Order Code RL31870

CRS Report for Congress

The Dominican Republic-Central America-UnitedStates Free Trade Agreement (CAFTA-DR)

Updated January 16, 2008

J. F. HornbeckSpecialist in International Trade and FinanceForeign Affairs, Defense, and Trade Division

Prepared for Members andCommittees of Congress

Congressional

Service

The Dominican Republic-Central America-United States

Free Trade Agreement (CAFTA-DR)

Summary

The United States Trade Representative (USTR) and trade ministers from Costa

Rica, El Salvador, Guatemala, Honduras, Nicaragua, and the Dominican Republic

signed the Dominican Republic-Central America-United States Free Trade

Agreement (CAFTA-DR) on August 5, 2004. Nearly one year later, it faced a

contentious debate and close vote in both houses of the U.S. Congress. The Senate

passed implementing legislation 54 to 45 on June 30, 2005, with the House following

in kind 217 to 215 on July 28, 2005. President Bush signed the legislation into law

on August 2, 2005 (P.L. 109-53, 119 Stat. 462). The United States has implemented

the agreement for El Salvador, Honduras, Nicaragua, Guatemala, and the Dominican

Republic. In Costa Rica, legislative consideration of CAFTA-DR has been a

prolonged process, culminating in the decision to hold a national referendum. On

October 7, 2007, the people of Costa Rica voted in favor of CAFTA-DR 51.6% to

48.4% (subject to official recount), setting the stage for final consideration by the

National Assembly.

The CAFTA-DR is a regional agreement with all parties subject to “the same

set of obligations and commitments,” but with each country defining its own market

access schedule. It is a reciprocal trade agreement, basically replacing U.S. unilateral

preferential trade treatment extended to these countries under the Caribbean Basin

Economic Recovery Act (CBERA), the Caribbean Basin Trade Partnership Act

(CBTPA), and the Generalized System of Preferences (GSP). It liberalizes trade in

goods, services, government procurement, intellectual property, and investment, and

addresses labor and environment issues. Most commercial and farm goods attain

duty-free status immediately. Remaining trade will have tariffs phased out

incrementally over five to twenty years. Duty-free treatment will be delayed longest

for the most sensitive agricultural products. To address asymmetrical development

and transition issues, the CAFTA-DR specifies rules for transitional safeguards, tariff

rate quotas, and trade capacity building.

The CAFTA-DR is not expected to have a large effect on the U.S. economy as

a whole given the relatively small size of the Central American economies and the

fact that most U.S. imports from the region had already been entering duty free under

normal trade relations or CBI and GSP preferential arrangements. Adjustments will

be slightly more difficult for some sectors, but none are expected to be severe.

Supporters see it as part of a policy foundation supportive of both improved

intraregional trade, as well as, long-term social, political, and economic development

in an area of strategic importance to the United States. Opponents wanted better

trade adjustment and capacity building policies to address the potentially negative

effects on certain import-competing sectors and their workers. They also argued that

the labor, intellectual property rights, and investment provisions in the CAFTA-DR

needed strengthening. This report discusses issues and evolution of the CAFTA-DR

debate and will be updated.

The Dominican Republic-Central America-United States Free Trade Agreement

On August 5, 2004, the United States Trade Representative (USTR) and tradeministers from Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and theDominican Republic signed the Dominican Republic-Central America-United StatesFree Trade Agreement (the CAFTA-DR; see Appendix 1, Chronology ofNegotiations). The CAFTA-DR is a regional trade agreement with all parties subjectto “the same set of obligations and commitments,” but with each country defming itsown market access schedule. It is a comprehensive and reciprocal trade agreement,replacing U.S. unilateral preferential trade treatment extended to these countriesunder the Caribbean Basin Economic Recovery Act (CBERA), the Caribbean BasinTrade Partnership Act (CBTPA), and the Generalized System ofPreferences (GSP).

The U.S. Congress did not consider implementing legislation for over a yearafter the CAFTA-DR was signed because it was so controversial. On June 30, 2005,the Senate passed S. 1307 by a vote of 54 to 45. The House followed on July 28,2005, passing H.R. 3045 by a vote of217 to 215. President Bush signed the bill intolaw on August 2, 2005 (P.L. 109-53, 119 Stat. 462). El Salvador, Honduras,Guatemala, the Dominican Republic, and Nicaragua also ratified the agreement, inthat order. The CAFTA-DR was expected to enter into force on January 1, 2006, butnone of the ratifying countries had completed the legal and regulatory measuresneeded to comply with the agreement. The USTR announced that the CAFTA-DRwould take effect on a rolling basis when countries fulfilled these obligations. Itentered into force on March 1, 2006 and has been implemented for El Salvador,Honduras, Nicaragua, Guatemala, and the Dominican Republic.

In Costa Rica, CAFTA-DR has been highly controversial because it wouldrequire major restructuring of public sector monopolies over electricity, insurance,and telecommunications. Public sector unions were at the center of this concern, butsmall farmers and other workers also voiced opposition. Oscar Arias won a slimpresidential victory in 2006 on a pro-CAFTA platform, but opposition in the NationalAssembly was able to delay consideration ofthe agreement. In the end, the ElectoralTribunal ruled in favor of a petition to hold a national referendum on the CAFTADR. On October 7, 2007, with a 60% participation rate, the people of Costa Ricavoted 5 1.6% to 48.4% in favor of CAFTA-DR. To be implemented for Costa Rica,the National Assembly must pass 13 implementing bills, which face continuingopposition in the legislature. To date, two have become law and the remainder arein various stages of consideration. Unless otherwise agreed to by all Parties to theCAFTA-DR, the agreement requires that it be implemented within two years of thedate when first entered into force (March 1, 2006), so Costa Rica is running a raceagainst the March 1, 2008 deadline and may yet decide to request an extension.

CRS-2

U.S. Congressional Action

The CAFTA-DR was the most controversial free trade agreement (FTA) vote

since the North American Free Trade Agreement (NAFTA) implementing legislation

was passed in 1993. Many lawmakers were uncomfortable with the agreement as

written, particularly with respect to the labor provisions, treatment ofcertain sensitive

industries (sugar and textiles), investor-state, pharmaceutical data protection, and

basic sovereignty issues. It was also caught up in an overarching congressional

controversy over how trade negotiation objectives are defined in FTAs based on the

Trade Promotion Authority (TPA) framework, as well as, concern by some Members

over the perceived ineffectiveness ofthe executive-legislative consultation process.’

These issues were raised repeatedly in “mock markups” of draft implementing

bills held by the Senate Finance and House Ways and Means Committees on June 14

and 15, 2005, respectively. The Senate Finance Committee voted 11-9 to approve

the draft legislation, with one non-binding amendment that would have extended the

trade adjustment assistance program to cover workers in services industries. The

House Ways and Means Committee voted 25-16 for approval of the draft legislation,

also adding a non-binding amendment with “a requirement that the Administration

report on activities conducted by the CAFTA-DR countries and the United States to

build capacity on labor issues,” and a provision requiring monitoring of CAFTA

DR’s effects on U.S. services industries. A “mock conference” was not held, to the

expressed consternation of some Members.

The Bush Administration sent the final implementing bill to Congress on June

23, 2005. It included a new Section 403, the House amendment requiring that the

Administration transmit biennial reports on progress made in implementing the labor

provisions, including the Labor Cooperation and Capacity Building Mechanism. It

also called for monitoring progress in meeting the challenges outlined in the so-called

White Paper on labor produced by the vice ministers of trade and labor of the

CAFTA-DR countries. Under TPA procedures, identical bills were introduced

jointly as H.R. 3045 and 5. 1307 and referred to the House Ways and Means and

Senate Finance Committees.

The Senate Finance Committee acted first, favorably reporting out S. 1307 by

voice vote on June 29, 2005. The House Ways and Means Committee followed suit,

reporting favorably by a vote of25 to 16 on June 30, 2005. The measure came before

the full Senate on June 30, 2005, where, following 20 hours of floor debate, 5. 1307

passed 54 to 45. H.R. 3045 did not come before the House until July 28, 2005,

where, following two hours of debate, it narrowly passed 217 to 215. On the same

day, the Senate voted 56 to 44 to substitute H.R. 3045 for S. 1307, a necessary

procedural vote to comply with the constitutional requirement that revenue bills

originate in the House. President Bush signed H.R. 3045 into law on August 2, 2005

(P.L. 109-53, 119 Stat. 462).

On TPA, see CRS Report RL743, Trade Promotion Authority: Issues, Options, and

Prospects, by J. F. Hombeck and William H. Cooper.

CRS-3

Passage in the Senate was by a slinuner margin than with earlier tradeagreements and required accommodation outside the implementing legislation tolabor, textile, and sugar interests. In a letter from USTR Rob Portrnan to Senator JeffBingaman, the Administration promised to allocate $40 million offiscal 2006 foreignoperations appropriations for “labor and environmental enforcement capacitybuilding assistance,” and to continue to request this level of funding in budgets forfiscal years 2007 through 2009. Some $3 million is to be used for fundingInternational Labor Organization (ILO) reporting on progress in labor lawenforcement and working conditions in these countries. An additional $10 millionannual commitment for five years was made for transitional rural assistance for ElSalvador, Guatemala, and the Dominican Republic, or until these countries canqualify for anticipated assistance from the U.S. Millennium Challenge Corporation.

In another letter, Secretary of Agriculture Mike Johanns assured Senator SaxbyChambliss and Representative Bob Goodlatte, the respective agriculture committeechairs, that the Administration would not allow the CAFTA-DR to interfere with theoperation of the sugar program as defined in the Farm Security and Rural InvestmentAct of 2002 (the Farm Bill) through FY2007, when it expires. In particular, hepromised to take steps should additional sugar imports due to the CAFTA-DR,NAFTA, and other trade agreements cause the import trigger threshold of 1.532million short tons per year be exceeded and jeopardize the sugar program operations.Should this occur, the U.S. Secretary of Agriculture agreed to preclude entry ofadditional sugar imports into the domestic sweetener market by either making directpayments to exporters or using agricultural commodities to purchase sugar to be usedfor nonfood use (ethanol production).

Separately, for the textile and apparel issues, promises were made to: (1) changethe rules of origin to require that all pocketings and linings come from the CAFTADR countries (rather than third party countries like China); (2) negotiate a newstricter customs enforcement agreement with Mexico before the CAFTA-DRcumulation rules take effect allowing Mexican inputs to be used in CAFTA-DRtextile and apparel products; and (3) require Nicaragua to increase use ofU.S. fabricto qualify as duty-free under their tariff preference levels.

Other accommodations were made to win House support of H.R. 3045,including passage in the House on July 27, 2005, of the U.S. Trade RightsEnforcement Act (H.R. 3283). This bill would allow greater recourse to pursue tradecomplaints against China and other non-market economies. Not all interest groups,however, could be appeased. Despite efforts to win over all groups, the sugarindustry and some textile groups chose not to support the bill and strong Democraticopposition remained over a number of other issues that may prove to be enduringchallenges to future trade agreements, if crafted from the CAFTA-DR framework.,

Why Trade More Freely?

Countries trade because it is in their national economic interest to do so, aproposition long supported by theory and practice. Comparative advantage has beenrecognized for nearly 200 years as a core principle explaining the efficiency gains

CRS-4

that can come from trade among countries by virtue oftheir fundamental differences.

It states that countries can improve their overall economic welfare by producing those

goods at which they are relatively more efficient, while trading for the rest. Intra

industry trade is the other major insight that explains trade patterns, in which the

benefits from exchange among countries occur based on specialized production,

product differentiation, and economies of scale. Many Latin American countries

have liberalized trade policies recognizing the contribution that trade (and related

investment) can make to economic growth and development. As an important

caveat, trade is at best only part of a broad development agenda, and is no substitute

for the promotion ofpolitical freedom, macroeconomic stability, sound institutions,

and the need for complementary social and economic policies.2

Comparative advantage provides the rationale for U.S.-Central American (and

Dominican Republic) trade in agriculture, textiles, apparel, and capital goods. Intra

industry trade (e.g., goods within the same harmonized tariff system (HTS) code

number) is based on specialized production, but in this case relies in large part on

differences in wages, skills, and productivity.3 Certain specialized jobs have

developed in Central America (and other developing countries), where they

frequently reside in production sharing (maquiladora) facilities. Economists have

come to refer to such specialized production as “breaking up the value added chain”

and it accounts for why products (and particularly parts thereof) as diverse as

automobiles, computers, and apparel are often made or assembled in Central America

and other countries in partnership with U.S. firms.4 This relationship, discussed in

more detail later, provides the basis for much of the labor policy debate on the

CAFTA-DR, and FTAs more generally.5

2 The role of trade is summarized well in: Rodrik, Dani. The New Global Economy and

Developing Countries: Making Openness Work. The Overseas Development Council,

Washington, D.C. 1999. p. 137 and Bouzas, Roberto and Saul Keifman. Making Trade

Liberalization Work. Afler the Washington Consensus: Restarting Growth and Reform in

Latin America. Kuczynski, Pedro-Pablo and John Williamson, eds. Institution for

International Economics. Washington, D.C. March, 2003. pp. 158, 165-67.

This differs from the standard intra-industTy case between two developed countries in

which goods, such as automobiles, are exchanged based on product differentiation and

economies of scale and where differences in wage levels are not a central factor.

For the theoretical foundation, see Krugrnan, Paul. Growing World Trade: Causes and

Consequences, in Brookings Papers on Economic Activity (1), William C. Brainard and

George L Perry, eds. 1995. pp. 327-76 and for the case in Central America, see Hufbauer,

Gary, Barbara Kotschwar, and John Wilson. Trade and Standards: A Look at Central

America. Institute for International Economics and the World Bank. 2002. PP. 992-96.

5Note that this trend has not been a driving force in the aggregate unemployment rate of the

United States, but does affect the distribution ofemployment among sectors ofthe economy.

It is also important to emphasize here that wage levels are only part of the issue. Lower

wages correlate closely with lower productivity, hence an abundance of low-skilled (low

productivity) workers attracts these types ofjobs. For a overview of the methodology of

measuring the effects of changes in trade policy, see Rivera, Sandra A. Key Methods for

Quantifying the Effects of Trade Liberalization. International Economic Review. United

States International Trade Commission. January/February 2003.

CRS-5

Measuring the benefits of freer trade is another difficult issue. There is atendency to count exports, imports, and the oft-misrepresented importance of thetrade balance as indicators of the fruits of trade. This approach often gives undueweight to exports at the expense of understanding benefits from imports, where thegains from trade are better understood by their contribution to increased consumerselection, lower priced goods, and improved productivity. For example, high-techintermediate goods imported from developed countries are the basis for future, moresophisticated, production in developing countries. In developed countries, importsfrom developing countries, whether final goods for consumers or inputs formanufacturing enterprises, reduce costs and contribute to productivity and economicwelfare. For all countries, exports are the means for paying for these imports andtheir attendant benefits.

Three caveats related to negotiating FTAs are important. First, the discussionof costs and benefits generally assumes that FTAs are implemented in a multilateralsetting. In fact, given the slow pace of World Trade Organization (WTO)negotiations, many countries are pursuing preferential arrangements, that is, regionaland bilateral agreements like the CAFTA-DR. Latin America is full of them anddepending on how they are defined, they may actually be trade distorting if theypromote trade diversion. This occurs when trade is redirected to countries within alimited agreement that does not take into account countries outside the agreement,some of which may be more efficient producers. Preferential trade agreements arealso cumbersome to manage, requiring extensive rules of origin, and economistsdisagree as to whether FTAs help or hinder the movement toward multilateral tradeliberalization.6

Second, trade, much like technology, is a force that changes economies. Itincreases opportunities for internationally competitive sectors and challenges importcompeting firms to become more efficient or do something else. This fact gives riseto the policy debate over adjustment strategies, because while consumers and exportsector workers benefit, some industries, workers, and communities are hurt.Economists generally argue that it is far less costly for society to rely on various typesof trade adjustment assistance than opt for selective protectionism, the frequent andforcefully argued choice oftrade-affected industries.7 The public policy difficulty isthat both options have costs and benefits, but result in different distributionaloutcomes.8 Because trade agreements raise difficult political choices for legislators

6U5 businesses operating in Latin America have had to interpret a difficult road map whendealing with multiple arrangements defined in the Caribbean Basin Trade Partnership Act,the Andean Trade Preference Act, and the North American Free Trade Agreement. Eachdistorts investment decisions in the region and can have a countervailing influence on theothers. Adding the many Latin American FTAs only makes the situation more confusing.‘ For a recent and accessible treatment of this subject, see Kletzer, Lori G. and HowardRosen. Easing the Adjustment Burden on US Workers. In: Bergsten, C. Fred., ed. TheUnited Stales and the World Economy. Washington, D.C.: Institute for InternationalEconomics, 2005. pp. 313-41.

8Jmpontly, when a staple, such as underwear, is produced abroad and sold in the UnitedStates as a lower-priced import compared to a domestically produced good, it is equivalent

(continued...)

CRS-6

in all countries, many of whom represent both potential winners and losers, FTA

provisions are typically limited in scope (so continue to protect partially or

completely certain products, industries, or sectors) and are phased in over time

(typically up to 15-20 years for very sensitive products).

Third, there are implications in the trade negotiation process for smaller

countries’ bargaining leverage when they choose to negotiate with a large country in

a bilateral rather than multilateral setting. Both Chile and the Central American

countries realized early in the process that there were negotiating issues over which

they would be able to exert little or no leverage. Both agreements, for example, do

not address antidumping and subsidies, reflecting an ongoing congressional concern,

and negotiations on certain agriculture issues were also limited, given the politically

sensitive nature of this issue.

The Impetus for a CAFTA-DR

The United States was motivated by both commercial and broader foreign

economic policy interests in deciding to negotiate preferential trade agreements with

Central America and the Dominican Republic. Geopolitical and strategic concerns

also sparked interest by all parties in pursuing the CAFTA-DR. Proponents expected

the CAFTA-DR to reinforce regional stability by providing institutional structures

that can undergird gains made in democracy, the rule of law, and efforts to fight

terrorism, organized crime, and drug trafficking. The CAFTA-DR may also be a way

to expand support for U.S. positions in the Free Trade Area ofthe Americas (FTAA),

and given that the January 2005 completion date has slipped, may also help

rationalize the system ofdisparate preferential trade agreements that currently define

Western Hemisphere trade relations.

Critics of the CAFTA-DR pointed to equally broad themes, such as the

pervasive social and economic inequality in much of the region, and so supported

strong labor and environment provisions as important negotiating objectives. There

was concern, for example, over the adequacy ofworking conditions and enforcement

of labor laws in the CAFTA-DR countries. The CAFTA-DR countries argued that

the agreement is one of many forces that can have a positive effect in raising labor

standards, although it is not sufficient to accomplish this goal on its own.

With the proliferation of regional agreements around the world, trade

negotiations have also become a tactical issue of picking off gains where they are

perceived relative to what other countries are doing. It was repeatedly argued by the

U.S. business community, for example, that the U.S.-Chile agreement, the first FTA

8 (...continued)to an increase in real income for the U.S. consumer. This can be significant for low-wage

workers in the United States. The same idea holds true for industrial products and business

consumers. So, there is a “trade off’ in the trade policy decision between keeping certain

jobs through protection and losing the income gains, or keeping the income gains and losing

certain jobs. One public policy response has been to pass trade adjustment assistance

legislation to help firms and workers transition more quickly to new opportunities.

CRS-7

after NAFTA, was necessary to equalize treatment ofU.S. businesses competing withCanadian finns that already enjoyed preferential treatment with Chile. The case wasmade for Central America as well, which has trade agreements with Canada andMexico, each with firms that compete with U.S. businesses in the region. Delayswith WTO and Free Trade Area of the Americas (FTAA) negotiations onlyreinforced this attitude.

In the context of regional trade agreements, history, geographic proximity, andeconomic complementarities also made the CAFTA-DR an apparently logical step.9Economic fundamentals shaped a trade relationship based on exports of traditionalagricultural products, and later apparel. From the early days of independence,agricultural exports were the centerpiece ofCentral American economic growth. TheBritish controlled primary export production (coffee, bananas, sugar, and beef) untilabout 1850, when U.S. interests won over. This trend continued until the 1 980s andpassage of the Caribbean Basin Economic Recovery Act (CBERA — P.L. 98-67),as part of the Caribbean Basin Initiative (CB1). By becoming eligible for unilateralpreferential tarifftreatment, U.S. investment increased in the region, fostering growthin Central American export sectors.

A major change to the CBI relationship occurred with passage of the CaribbeanBasin Trade Partnership Act of 2000 (P.L. 106-200). Tn response to repeatedconcerns over trade benefits negotiated with Mexico underNAFTA, Congress passedessentially NAFTA-equivalent treatment for the CBI countries. CBTPA targetedpreferences on textile, apparel, and other high-volume export goods not coveredunder the original CBI legislation. The benefits were extended temporarily for aperiod ending September 30, 2008, or until a beneficiary country enters into an FTAwith the United States.

The U.S.-Central American/Dominican Republic economic relationship changedimportantly under the CBTPA, creating an environment in which businesses forgedstrategic partnerships in the increasingly complex world of textile and garmentmanufacturing. From 1974 until 1995, global rules restricting trade in apparelbetween developed and developing countries (mostly quotas) were set out in theMultifiber Arrangement (MFA) and its successor, the WTO-sponsored Agreementon Textiles and Clothing (ATC), which served as a transitional arrangement to aquota-free system begun on January 1,2005. In this context, the CBTPA preferencesprovided an import benefit for the region’s export sectors.1°

The United States created the CBIJCBTPA to foster Caribbean economicdevelopment and to assist U.S. industry in responding to competition from similarproduction-sharing arrangements in Asia that were taking a toll on U.S. productionand employment in the textile and apparel industries. Still, U.S. textile andparticularly apparel industries have been hit hard by foreign competition, resulting

For an excellent economic history of the region, see Woodward, Ralph Lee Jr. CentralAmerica: A Nation Divided New York: Oxford University Press, third edition, 1999.10 For more on the evolution of these trade preference arrangements, see CRS ReportRL3395 1, US. Trade Policy and the Caribbean: From Trade Preferences to Free TradeAgreements, by J. F. Hombeck.

CRS-8

in a total job loss ofover 540,000 employees from 1998-2002.” The textile industry

(e.g., fiber, yams, fabric) has remained marginally competitive through use of

sophisticated production technologies. The apparel manufacturing industry (e.g.,

shirts, pants, undergarments) by contrast, is highly labor intensive, and in striving to

reduce costs, has moved production offshore to lower-wage countries.

As defined in the CBTPA, U.S. firms, through subsidiary or contractual

anangernents, are required to use mostly U.S. textiles as inputs to products that are

assembled and exported back to the United States — a mutually beneficial strategy.

In 2002, some 56% of U.S. apparel and textile imports from Central America was

assembled from U.S. materials, compared to less than 1% for apparel imports from

China.’2 Although this was a controversial move because of the reliance on foreign

low-wage workers to the detriment of some U.S. employment, many economists

argued that the alternative would have been an even greater loss of textile and

garment jobs to Asian competitors that use no U.S. inputs.’3

With the removal oftextile and apparel quotas in January 2005, the trade picture

changed again. The CAFTA-DR countries were already losing U.S. market share,

which from 1997 to 2002 declined from 11.7% to 9.4%. Over the same time period,

China’s market share increased from 9.1% to 13.0%. Given that U.S. textile and

apparel imports from CAFTA-DR countries are heavily concentrated in products

previously covered by quotas, the dominance of China and other low-cost Asian

producers is likely to continue. CAFTA-DR producers are less competitive on a pure

cost basis because of their higher labor costs relative to Asia, the CBTPA

requirement to use more expensive U.S. inputs, and the additional administrative

costs associated with U.S. preferential trade requirements.’4

Low-cost labor, however, is not the only or even the most important factor

driving competitiveness.’5 Studies suggest that the economic and social networks

that developed between U.S. and Central American firms effectively created a niche

“ United States International Trade Commission (USITC). The Economic Effects of

SignfIcant US. Import Restraints. Publication 3701. Washington, DC, June 2004. p. 60.

12 USITC. Production-Sharing Update: Developments in 2001. Industiy Trade and

Technology Review. November 2003. PP. 22 and B-l-4.

13 Chacón, Francisco. International Trade in Textile and Garments: Global Restructuring

of Sources of Supply in the United States in the I 990s. Integration and Trade, Vol. 4, No.

11, May-August 2000. Inter-American Development Bank, Washington, D.C. and United

States International Trade Commission. Production-Sharing Update: Developments in 2002.

Industry Trade and Technology Review. November 2003. p. 12.

‘‘ United States International Trade Commission. Textiles and Apparel: Assessment ofthe

Competitiveness ofCertain Foreign Suppliers to the US. Market. USITC Publication 3671.

Washington, D.C. January 2004. pp. 1-12, 3-22, and 3-33-35.

more subtle distinction made by one economist notes that, “How comparative advantage

is created matters. Low-wage foreign competition arising from an abundance of workers

is different from competition that is created by foreign labor practices that violate norms at

home. Low wages that result from demography or history are very different from low wages

that result from government repression ofunions.” See Rodrik, Dani. “Sense and Nonsense

in the Globalization Debate.” Foreign Policy. Summer 1997. p. 28.

CRS-9

market in the region for certain apparel that has held up even with the growingpresence of China in the market. This relationship was made possible by theproximity of production, operational efficiencies, and quick turn around times formeeting increasingly shortened deadlines demanded by large retailers. In a post-quota trading world, these advantages may allow a certain portion of textile andapparel production to remain in the CAFTA-DR countries. Although CAFTA-DRcountry representatives have emphasized that the passage ofthe free trade agreementis a critical component for maintaining this strategy, it is not certain that it cancounter the long-tenri trend in market share loss to Asia.’6

Strategic considerations were important, but ultimately it is fair to ask what eachcountry expects to gain commercially from the detailed agreement that has emerged.The dollar value of U.S. trade with Central America makes the region the UnitedStates’ third largest Latin American trading partner, right behind Brazil, but a fardistant third from Mexico. Still, these are small economies (see Appendix 2 foreconomic data) and although firms engaged in this trade may fmd its effectssignificant, total CAFTA-DR trade in 2004 represented only 1.5% of U.S. foreigncommerce, and so can be expected to have only a small macroeconomic effect.

For the United States, an FTA is a more balanced trade arrangement than theunilateral preferences provided in the CBIICBTPA. Market access issues (e.g., tariffrates, quotas, rules of origin) were core negotiating areas. Although CentralAmerican and Dominican tariffs were already relatively low, they were reducedfurther. In particular, U.S. business interests wanted equal or better treatment thanthat afforded to exports from Canada and Mexico based on their FTAs with CentralAmerican countries. Permanent and clarified trade rules also supported the jointproduction arrangements already in place between U.S. firms and those in the region.Finally, a bilateral agreement offered the United States a chance to deepen other tradecommitments that affect some of its most competitive industries, including rulescovering the treatment of intellectual property, foreign investment, governmentprocurement, e-commerce, and services.

From the Central American and Dominican perspectives, reducing barriers tothe U.S. market (especially for textile and agricultural products) was cause enoughto proceed. The CAFTA-DR also made permanent and expanded U.S. benefits givenunder the CBTPA legislation, but which require reauthorization by Congress.Permanence in trade rules is an enticement for U.S. foreign direct investment (FDI),which in turn can support the region’s export driven development strategy.

The CAFTA-DR countries also faced important vulnerabilities, such as thepossibility that U.S. agricultural exports of key staples, such as corn and rice, mightoverwhelm their small markets. Sensitivity to these and other key industry sectorswere addressed in the extended tariff phase-out and safeguard schedules, and as a

‘6USITC, Textiles andApparel, pp. 3-33, 4-2-4. Gereffi, Gary. The Transformation of theNorth American Apparel Industry: Is NAFTA a Curse or a Blessing? Integration andTrade. Vol. 4, No. 11. May-August 2000. Inter-American Development Bank. pp. 56-57.

CRS-1O

matter of development policy, by CAFTA-DR country efforts to diversify the

agricultural sector into non-traditional exports and non-farm employment.’7

Finally, there were two significant negotiation challenges. The first was the

need for better Central American integration as part of CAFTA-DR, which

historically has been hampered. Having multiple trade rules and rules of origin in a

small sub-region would complicate the trade picture. For the CAFTA-DR to work

well, the United States needed some assurance that goods would flow efficiently

within the region, which will be a significant benefit of the agreement, particularly

with Costa Rica heading toward ratification of CAFTA-DR. Second, there was a

difference in negotiating capacity between Central America and the United States.

U.S. and multilateral offers to assist these countries in developing such capacity were

viewed as generous, but also a little self-serving, which required sensitivity in the

negotiation process.

U.S. Trade Relations with Central Americaand the Dominican Republic

“Docking” the Dominican Republic FTA to CAFTA added the largest of six

trading partners covered by the CAFTA-DR agreement. Total U.S. trade with the

Dominican Republic in 2004 was one-third greater than with either Costa Rica or

Honduras, which tie as the next largest U.S. trading partner in Central America.

What made the process feasible was the Dominican Republic’s willingness to accept

the basic framework and rules ofCAFTA, while negotiating market access and some

other issues bilaterally, as was done with each ofthe five Central American republics.

In addition, the Dominican Republic’s economy and export regime are, in many

ways, similar to those of Central America. U.S.-Dominican Republic trade was

added to an earlier version of this report and is discussed in more detail separately.

U.S.-Central America Trade

Because ofits huge size and geographical proximity, the U.S. market is a natural

destination for Central American exports. Merchandise trade with the United States

has dominated Central America’s foreign commerce for 1 50 years, and as seen in

Figure 1, remains in that role today.

17 The CAFTA-DR countries have begun new exports projects in areas such as miniature

vegetables, cut flowers, cable manufacturing, among others, in expectation that moving

beyond subsistence agriculture and textile manufacturing is critical to achieve economic

diversification and development. What distinguishes this effort from the earlier agricultural

export model is the emphasis on integrating small producers into the export system. The

idea is not only to tap into naturally small production capabilities, but to help bring social

development to areas that previously were not integrated into the agricultural export

development model. It is still a relatively small effort and its widespread application has yet

to be fully realized, but the CAFTA-DR countries see the FTA as supporting this strategy.

CRS-ll

Figure 1. Central America’s Direction of Merchandise Trade, 2003

Data Source: IMF, Direction ofTrade StaIisIics 2004 Yearbook.

The United States is by far the largest of Central America’s trading partners,accounting for some 56% of its exports and 44% of its imports. The rest of LatinAmerica collectively is the next largest trading partner, accounting for 25% ofCentral America’s exports and 31% of its imports. The European Union and Asiatogether account for about 14% of Central American exports and 21% of imports.

This distribution is not uniform throughout the region. Honduras, for example,exports 67% of its merchandise goods to the United States, compared to 44% forCosta Rica. Honduras also has the highest import percentage from the United Statesat 53% compared to Nicaragua’s 25%, which is the lowest. Total trade (exports plusimports) with the United States is also somewhat uneven country by country. CostaRica accounts for 30% of total Central American trade with the United States,whereas Nicaragua amounts to only 5% of the total. Guatemala, Honduras, and ElSalvador account for 25%, 22%, and 18% respectively.

Trade volume with the United States varies among countries, but in most casesthe trend has been one of growth at a rate higher than the average for U.S. trade withthe world. Over the past five years, U.S. exports to Central America grew by 34.7%(25.3% including the Dominican Republic), compared to 17.6% with the world and21.2% with Latin America as a whole (see Appendix 3 for the data). U.S. importsfrom Central America increased by 19.3% (15.4% including the DominicanRepublic) over the same time period, compared to 43.4% from the world and 51.4%from Latin America. Importantly, in 2003 some 80% of imports from CentralAmerica and the Dominican Republic entered the United States duty free under eithernormal trade relations (NTR) status or the CBI or GSP programs.18

Central American Exports Central American Imports

United States International Trade Commission. US.-Central America-DominicanRepublic Free Trade Agreement: Potential Econoniywide and Selected Sectoral Effects.

(continued...)

CRS-12

For 2004, although trade growth varied among the five countries, U.S. export

growth to Central America doubled average export growth to the world, with all five

countries experiencing solid growth. U.S. imports from Central America, by

contrast, grew by less than half that of average import growth from the world. As

these trends suggest, the United States tends to run small merchandise trade deficits

with all the Central American countries and the Dominican Republic. In part, this

is the nature ofa production-sharing trade relationship, where parts and materials are

sent abroad for value-added processing and then returned to the United States.

Importantly, when services trade is added to the trade balance, the United States

tends to run trade surpluses with all these countries. This trend, too, is indicative of

the basic relationship between the United States, a service-based economy, and

developing countries.’9

U.S. Imports. Nearly three-quarters ofU.S. imports from Central America fall

into three main categories: fruit (mostly bananas) and coffee; apparel; and integrated

circuits. These three distinct categories, for various reasons, are not traded uniformly

by the five countries (see Table 1).

First, Central America has traditionally exported bananas and coffee, which is

dominated by Costa Rica and Guatemala. Coffee has actually declined for all

countries except Costa Rica and constitutes only 3.8% of U.S. imports from the

region. This reflects the competitive nature oftrade in coffee, which is grown in vast

quantities by Brazil, Colombia, and countries in Africa as well. Banana trade has

also declined in importance and accounts for only 5.0% ofU.S. imports from Central

America.

Second, knit and woven apparel has become the primary export goods for all

countries except Costa Rica and accounts for nearly 57% of total U.S. imports from

Central America. Because ofthe CBTPA benefits, some 56% oftextiles and apparel

imported from the six CAFTA-DR countries in 2002 was assembled from U.S. fabric

(from U.S. yarns). Of that amount, the Dominican Republic had 33% of the total

followed by Honduras with 30%, El Salvador with 18%, Costa Rica with 9%,

Guatemala with 8%, and Nicaragua with 2%. Under the CBTPA, these countries

may engage in greater value-added operations such as cutting and dyeing, which has

allowed them to remain selectively competitive with low-cost Asian exports. These

restrictions are further relaxed under the CAFTA-DR.2°The USITC points out that

‘ (...continued)USITC Publication 3717. August 2004. p. 7.

‘ This trend is not disputed, but the U.S. Department of Commerce does not disaggregate

U.S. bilateral services trade data with the Central American countries. Estimates are

provided in some of the Country Commercial Guides produced by the U.S. Department of

Commerce based on foreign country reporting.

20 United States International Trade Commission. Production-Sharing Update:

Developments in 2001. Industi-v Trade and Technology Review. November 2003. pp. 13,

22, Bl-4.

CRS-13

the CAFTA-DR countries have been losing market share to Asia since at least 1997,‘1and the CAFTA-DR is seen as a way to help abate this trend:

Table 1. Top Eight U.S. Merchandise Imports from CentralAmerica, 2004

($ millions): -

4pduct and HTSa4Total C R. .- Hon Guat El Sal Nic

-.-..

Total U.S. liriports 13,172 3,333 3,641 3,155 2,033 991

KnitApparel(61) 5,108 253 2,013 1,261 1,364 216

WovenApparel(62) 2,415 265 729 686 357 379

Edible Fruit & Nuts (08) 1,037 490 172 359 0 14-Bananas (0803) (657) (245) (129) (273) (0) (11)

Electrical Mach. (85) 983 719 172 1 18 73-Integrated circuits 8542 (489) (489) (0) (0) (0) (0)

Optical/Med. Equip. (90) 492 480 0 12 0 0

Spices, Coffee, Tea (09) 512 150 45 216 49 52-Coffee (0901) (504) (148) (43) (213) (49) (52)

FishandSeafood(03) 293 60 133 22 6 74

Mineral Fuel, Oil (27) 186 0 0 180 6 0

Other 2,146 916 377 418 233 183

Top 8 as % of Total 83.7% 72.5% 89.6% 86.8% 88.5% 8 1.5%Data Source: U.S. Department of Commerce.#HTS = Harmonized Tariff Schedule

Third, Costa Rica attracted $500 million in foreign direct investment for acomputer chip assembly and testing plant, which has become its major exportgenerator. This investment was augmented by an additional $110 million in October2003 for the production line of “chipsets” for personal computers. In 2004, U.S.imports of integrated circuits constituted 18% of total imports from Costa Rica.Similar importance may be seen in the imports of Costa Rica’s medical equipment,another indicator of its relatively sophisticated production capabilities. Costa Ricais the fastest growing and most diversified trader in Central America, which explains,in part, why it has outpaced its neighbors on the development path.22

The CAFTA-DR is intended to build on these trends, support exportdiversification, and provide a long-term stable trade environment that will increaseU.S. foreign investment in the region. Evidence is already seen in alternativeagricultural exports such as cut flowers and miniature vegetables (in multipleCAFTA-DR countries), as well as, developing maquiladora operations to suppiy coilwrapped cables for the automotive sector (Honduras) and adapting apparel cuttingtechnology to supply insulation for aircraft engines (Costa Rica). Many non-apparel

21 USITC, Textiles and Apparel, p. 1-12.22 Hufbauer, Kotschwar, and Wilson, op. cit., p. 1003.

CRS-14

items that the United States imports from Central America face minimal or no tariffs.

Bananas, coffee, oil, most fish products, and Costa Rica’s integrated circuits and

medical equipment enter duty free. Some enter the United States under preferential

arrangements, but the majority is free of duty under normal (most favored nation —

MFN) tariff rates. Rules on U.S. apparel imports were enhanced and made

permanent under CAFTA-DR.

U.S. Exports. As seen in Table 2, the major U.S. exports to Central America

include electrical and office machinery (computers), apparel, yarn, fabric, and plastic.

Many of these goods are processed in some form and re-exported back to the United

States under production-sharing arrangements. For example, nearly 60% ofelectrical

machinery exports to Central America is integrated circuits going to Costa Rica for

processing and re-export. The same may be said for fabric and yams that are

exported to all countries, sewn and otherwise assembled, and re-exported back to the

United States. Some ofthese goods are consumed in the CAFTA-DR countries along

with capital goods (machinery and parts) and agricultural products.

Table 2. Top Eight U.S. Merchandise Exports to CentralAmerica, 2004

$ millions)

Product and HTS Costa PTotal . Hon Gnat El Sal Nic

Numbea. Thca

Total U.S. Exports 11,388 3,304 3,077 2,548 1,868 592

ElecMachinery(85) 1,698 1,092 175 206 157 68

-Integrated circuits 8542 (828) (822) (0) (5) (1) (0)

Machinery (84) 1,031 301 205 256 205 69

-Office Mach. Pts (8473) (207) (68) (26) (62) (32) (19)

-Computer Parts (8471) (136) (43) (20) (32) (26) (10)

Cotton Yam, Fabric (52) 780 18 412 241 84 23

Mineral Fuel (27) 712 93 239 313 57 10

Knit/Crocheted Fabric 60 688 38 351 24 272 3

Plastic (39) 657 253 123 181 87 13

KnitApparel(61) 624 101 312 33 176 2

Cereals (10) 559 156 92 118 125 68

-Corn (1005) (242) (71) (31) (65) (64) (10)

-Wheat and Meslin 1001 (167) (38) (28) (34) (46) (21)

-Rice (1006) (149) (46) (33) (18) (16) (37)

Other 4,639 1,252 1,168 1,176 705 336

Top 8 as % of Total 59.3% 62.1% 62.0% 53.8% 62.3% 43.2%

Data Source: U.S. Department of Commerce. HTS Harmonized Tariff Schedule

Similar trends for U.S. import trade are evident in U.S. exports. In 2004, 78%

of knit apparel and 76% of knit, cotton, and yarn fabric went to Honduras and El

Salvador. Although the United States exports machinery and parts to all five

countries, electrical machinery and particularly integrated circuits, are sent to Costa

Rica. All five countries import U.S. cereals and some, such as corn and rice, are

CRS-15

among the more import sensitive products for the CAFTA-DR countries because theyare staple crops and grown by small, often subsistence fanners.23

The significant aspects of this trade structure are that it reflects: 1) the continuedhistorical trend of (largely duty-free) regional dependence on the large U.S. marketas an important aspect of trade and development policy; 2) a deepening economicintegration; and 3) growing U.S. direct investment over the long run.

U.S.-Dominican Republic Trade

The Dominican Republic is the 28t largest U.S. export market (6th in LatinAmerica) and ranks as the 41st largest import country (8th in Latin America). Moreso than any of the Central American countries, Dominican trade is dominated by theUnited States (see Table 3 for bilateral trade data.)

Table 3. U.S.-Dominican Republic Merchandise Trade, 2004U S Exports (by product

$ minions U S Imports (by product$ millionsand HTS Number*) and fiTS Number*) -

Electrical Machinery (85) 529 Woven Apparel (62) 1,147

Knit Apparel (27) 379 Knit Apparel (61) 889

Cotton Yar, Fabric (52) 301 Medical listruments (90) 417

Oil (not crude) (27) 291 Electrical Machinery (85) 393

Plastic (39) 235 Precious Stones/Jewelry(71) 341

Machinery (84) 230 Tobacco (24) 227

Precious Stones/Jewelry(71) 219 fron and Steal (73) 161

Cereals (10) 185 Footwear (64) 137

Other 1,974 Other 816

Total 4,343 Total 4,528

Top 8 Exports as % of Total 54.5% Top 8 Imports as % of Total 82.0%Data Source: U.S. Department of Commerce. #HTS = Harmonized Tariff Schedule

The United States absorbs 80% of its exports, with 12% going to otherdeveloped countries and only 8% entering developing countries. The DominicanRepublic imports 50% of its merchandise goods from the United States, 13% fromother developed economies, and 37% from various developing countries. Althoughthe largest of the CAFTA-DR trading partners, U.S. exports grew by only 1.6% in2004 as the Dominican Republic continued to recover from a severe recession.

The joint-production arrangements are evident in apparel and jewelry-makingindustries. Apparel and textiles constitute 16% of U.S. exports and 48% of U.S.imports. Other significant U.S. exports include various types of machinery, refinedoil products, and plastic. Other important U.S. imports include medical instruments,

USITC, Production-Sharing Update: Developments in 2001. Industry Trade andTechnology Review. July 2002. pp. 39-42, Bl-4

-o9CRS-16

electrical machinery, tobacco, and plastic. In many ways, the structure of the U.S.-

Dominican trade is similar to that of U.S.-CAFTA trade, and hence the economic

logic of “docking” it to the Central American agreement.

U.S. Foreign Direct Investment

The CAFTA-DR countries also benefit from foreign direct investment (FDI) as

part of the trade relationship with the United States, which is the largest foreign

investor in all six countries. To the extent that an FTA can be considered a

stabilizing factor in economic relationships, it is expected to encourage more FDI and

thereby promote longer term economic growth and development. U.S. FDI in the

CAFTA countries is presented in Table 4.

The trends suggest that U.S. direct investment in the area is relatively small and

has stagnated or grown erratically in recent years. Some countries have fared better

than others and net foreign investment may increase or decrease because of both

economic and political trends, as well as opportunities in other parts of the world that

can affect business decisions. Investment patterns have been skewed toward Costa

Rica, which has over half of U.S. FDI in Central America.

Table 4. U.S. Foreign Direct Investment (FDI)in CAFTA-DR Countries

(S millions)

Country 1999 2000

Costa Rica 1,493 1,716 1,835 1,802 1,831

El Salvador 621 540 464 684 779

Guatemala 478 835 311 303 294

Honduras 347 399 227 181 270

Nicaragua 119 140 157 250 261

Total Central America 3,058 3,630 2,994 3,220 3,435

Dominican Republic 968 1,143 1,116 983 860

Total CAFTA-DR 4,026 4,773 4,1 10 4,203 4,295

Data Source: U.S. Department of Commerce. Bureau of Economic Analysis. Available at

[http://www.bea.doc.gov/bealdilusdlongcty.htmj. Data are stock of FDI on a historical-cost basis.

Review of the CAFTA-DR

One aspect of the congressional debate over trade agreements focused on their

potential economic effects on the United States. Congress mandated that the United

States International Trade Commission (USITC) assess these effects and it released

its final report in August 2004. This report provides quantitative and qualitative

estimates of the CAFTA-DR effects on the U.S. economy as a whole and for selected

sectors. Overall, it found that the “welfare value” or aggregate effect on U.S.

consumers and households of trade liberalization under the CAFTA-DR would be

lD

CRS-17

approximately $166 million (less than 0.0 1% of GDP) for each year the agreementis in effect.24

With respect to trade flows, the reduction ofrelatively higher tariffrates on U.S.goods is expected to increase U.S. exports more than imports with the region. TheUSITC model estimates that when the CAFTA-DR is fully implemented, U.S.exports to the CAFTA-DR countries will increase by $2.7 billion or 15%, whileimports will increase by $2.8 billion, or 12%. The effect of this trade growth onaggregate U.S. output and employment is estimated to be minimal. The largest sectorincreases were estimated to occur for U.S. grains (0.29% for output and 0.3 1% foremployment) and the greatest decrease to occur for sugar manufacturing (-2.0% forboth output and employment).25 These estimates are in line with expectations madeprior to the negotiations that the marginal effects of the CAFTA-DR will be small,but positive for the U.S. economy as a whole, given the CAFTA-DR countries hadsmall and already largely open economies.

The rest of this section briefly summarizes the major negotiation issues andreferences the ITC’s conclusions with respect to each major issue area, whereapplicable. Emphasis is given to those sectors and issues expected to be mostaffected by the agreement, or that generated the most contentious policy debate.

Market Access

Market access refers to provisions that govern barriers to trade such as tariffs,quotas, safeguards, and rules of origin, which define goods eligible for tariffpreferences based on their regional content. CAFTA-DR replaces and enhances ina permanent agreement U.S. preferential market access extended unilaterally underthe Caribbean Basin Economic Recover Act (CBERA), the Caribbean Basin TradePartnership Act (CBTPA), and the Generalized System ofPreferences (GSP), whichrequire periodic congressional reauthorization (except CBERA). Agriculture andtextile/apparel goods, Central America’s major exports, were the most important anddifficult market access issues to resolve.

Each traded good falls into one of eight tariff elimination “staging categories,”which defme the time period over which customs duties will be eliminated. Eachcountry negotiated a list of its most sensitive products for which duty-free treatmentis delayed. For manufactured goods, duties on 80% ofU.S. exports were eliminatedimmediately, with the rest phased out over a period of up to 10 years.26 Foragricultural goods, duties on over 50% ofU.S. exports were eliminated immediately,with the rest phased out over a period of up to 20 years. In some cases, duty-freetreatment is “back loaded” and will not begin for 7 or 12 years after the agreement

24 USITC, US.-C’entral America-Dominican Republic Free Trade Agreement, p. 64. Thestudy reviews literature on the CAFTA-DR and makes estimates of the economywide andsectoral effects of trade liberalization under CAFTA-DR based on a computable generalequilibrium (CGE) model. For details, see pages xiv, 2, and Appendix D.25 Ibid., pp. xxii and 64-70.26 Ibid., p. 25.

CRS-18

takes effect. For the CAFTA-DR countries, 100% ofnon-textile and non-agricultural

goods enter the United States duty free immediately.27 Safeguards are retained for

many products over the period ofduty phase out, but antidumping and countervailing

duties were not addressed in the CAFTA-DR, leaving all U.S. and other country trade

remedy laws fully enforceable, as required under Trade Promotion Authority (TPA).

Textiles and Apparel. The CAFTA-DR has less restrictive provisions

governing textile and apparel imports than those in the CBTPA. It removes all duties

on textile and apparel imports that qualify under the agreement’s rules of origin,

retroactive to January 1, 2004, and allows for special safeguard measures during the

duty phase-out period. The penrianence of the provisions and the more

accommodating rules of origin and administrative guidelines may generate a

marginal increase in apparel imports from the region. These provisions are intended

to address the decline in U.S. market share of textile and apparel imports from the

region over the past five years, most ofwhich have been displaced by Asian products,

despite the enhanced preferential treatment that Congress afforded to Central

American and Dominican imports under the CBTPA.28

Central American and Dominican apparel has been entering the United States

duty free for years, if it is assembled from U.S. yam and fabric under the so-called

“yarn forward” rule. The difference from the CBTPA is that duty-free access applies

to textiles and garments assembled from components made in either the CAFTA-DR

countries or the United States, rather thanjust the United States.29 Exceptions to this

rule include an enhanced “cumulation rule,” which allows duty-free treatment for a

limited quantity ofwoven apparel assembled from components made in Canada and

Mexico, to help U.S. textile firms invested in these countries. In addition, there are

exceptions for specified products (affecting less than 10% of trade), goods with

limited amounts of material from third countries, and for tariff preference levels

(TPLs) given to a few imports from Nicaragua and Costa Rica.

Although these rules were widely supported, some textile producers registered

concern that they are overly restrictive and therefore limited in their intended effect

of helping the region compete (by lowering costs) in the U.S. market against Asian

imports. U.S. and CAFTA-DR firms that produce for the U.S. market wanted as

much flexibility as possible to use fabrics from third countries. Others feared,

however, that they are too generous and that if customs procedures are not well

implemented, they could harm U.S. producers by increasing opportunities for the

illegal transshipment of fabrics or goods originating from outside the region, such as

China. There was also considerable debate over the expansion from the CBTPA of

the “short-supply” list. This is the list of goods given duty-free access if made from

materials that are determined to be commercially in “short supply” in the United

States. The CAFTA-DR may also increase U.S. exports of textiles, which have risen

27 Office of United States Trade Representative. Free Trade with Central America:

Summary ofthe US. -central America Free Trade Agreement. p. 1. Hereafter cited as the

CAFTA Suminaty. It may be found at [http://www.ustr.govj.

28 USITC, U.S. -Central American-Dominican Free Trade Agreement, pp. 28-29.

29 See CRS Report RS22 150, CAFTA-DR: Textiles andApparel, by Bernard A. Geib. p. 4.

CRS-19

significantly under CBTPA. On balance, however, the USITC study estimated thatit “will likely have a negligible impact on U.S. production or employment.”30

Concerns raised by certain sectors of the textile and apparel industry requiredassurances from the Bush Administration before support would be given to theCAFTA-DR. Promises were made to: (1) change the rules of origin for textiles andapparel to require that all pocketings and linings come from the CAFTA-DRcountries (rather than third party countries like China); (2) negotiate a new strictercustoms enforcement agreement with Mexico before the CAFTA-DR cumulationrules take effect allowing Mexican inputs to be used in CAFTA-DR textile andapparel products; and (3) require Nicaragua to increase use of U.S. fabric to qualifyas duty-free under their tariff preference levels. These assurances are not part of theformal CAFTA-DR, but have been implemented nonetheless.3’

Agriculture. Domestic support programs were not addressed in the CAFTADR, which focused on reducing tariffs and increasing quota levels, the most costlytrade-distorting policies. Average applied tariffs on agricultural goods by mostCAFTA-DR countries are relatively low, ranging from 7% to 23%. Most agriculturalimports face no tariff in the United States. For all countries, the pressing challengewas negotiating tariff rate quotas (TRQs — see below) for their most sensitiveproducts.32 Agricultural products have the most generous tariffphase-out schedules,with up to 20 years for some products (e.g., rice and dairy). This approachacknowledges that the agricultural sectors bear most ofthe trade adjustment costs andthat they will require time to make the transition to freer trade.33

All agricultural trade eventually becomes duty-free except for sugar importedby the United States, fresh potatoes and onions imported by Costa Rica, and whitecorn imported by the other Central American countries. These goods will continueto be subject to quotas that will increase, after a certain period, by approximately 2%each year in perpetuity, with no decrease in the size of the above-quota tariff.34 Overhalf of current U.S. farm exports to Central America became duty free upon

30CRS Report P.132895, Textile Exports to Trade Preference Regions, p. 2, by Bernard A.Geib. Inside U.S. Trade. CAFTA Textile Rules Pave Wayfor Increase in Foreign FabricUse. December 19, 2003 and Press Release. NTA Denounces CAFTA as Threat to US.Textile Industry. December 18, 2003 and USTR, CAFTA Summary, p. 2 and USITC, US.-Central American-Dominican Republic FTA, p. 30-32. Nicaragua received specialpreferential treatment for certain “non-originating apparel goods”(Annex 3.27) and CostaRica received limited special treatment for certain wool apparel goods (Annex 3.28).31 Washington Trade Daily, Tide Risingfor CAFTA Portman, July 26, 2005.32 For more details, including sanitary and phytosantiary (SPS) provisions, see CRS ReportRL32 110, Agricultural Trade in the US. -Dominican Republic-Central American FreeTrade Agreement (CAFTA-DR), by Remy Jurenas.‘ Salazar-Xirinachs, Jose M. and Jaime Granados. The US-Central America Free TradeAgreement: Opportunities and Challenges. In: Schott, Jeffrey J. ed. Free TradeAgreements: US Strategies and Priorities. Washington, D.C. Institute for InternationalEconomics. 2004. pp. 245-46.“ CRS Report RL321 10, Agriculture in the US.-Dominican Republic-CentralAmericanFree Trade Agreement (CAFTA-DR,), by Remy Jurenas.

CRS-20

implementation, including high quality cuts ofbeef, cotton, wheat, soybeans, certain

fruits and vegetables, processed food products, and wine.

Many other transitional provisions exist. Agricultural products are subject to

tariff-rate quotas, or limits on the quantity of imports that can enter the United States

before a very high tariff is applied. The phased reduction in agriculture protection

also includes the transitional use of volume-triggered safeguards, or applying an

additional duty temporarily on products that are being imported in quantities deemed

a threat to the domestic industry.35 Export subsidies are eliminated except when

responding to third party export subsidies.

Sugar was the most controversial agricultural issue to resolve and U.S. sugar

growers and processors were vehement opponents of the agreement to the end. The

U.S. agreed to slight numerical increases in sugar quotas for all six countries. Sugar

and sugar-containing products imported under the U.S. quota system enter the United

States duty-free, but exports above the quota face prohibitive tariffs. Raw sugar

receives the largest quota by volume, 28% of the total U.S. sugar quota for the world

was filled by the CAFTA-DR countries in 2003, and was a major issue for this

agreement. The U.S. market accounts for only 14% of the region’s sugar exports,

representing less than 10% of the region’s sugar production.36

The CAFTA-DR raises the U.S. quota by an amount equal to 35% ofthe current

quota in year one, rising to 50% by year 15, after which the quota increases each year

slightly in perpetuity. This may seem large, but the USITC notes that the initial

increase amounts to only 1% of U.S. production and consumption of raw sugar in

2003, and that the overall effects of the sugar provisions may be small. Two studies

done by the USITC and Louisiana State University estimated that the sugar

provisions could result in a decline in sugar prices of 1% (USITC) and 4.6% (LSU),

with perhaps largely offsetting employment effects in the sugar producing and sugar-

containing product industries.37 The United States may impose a sugar price

mechanism to compensate Central American sugar exporters in lieu of according

them duty-free treatment, but a key issue for some Members of Congress was

defining precisely how this mechanism will work.

Nonetheless, the sugar producing industry remained unsatisfied with these

provisions. The Bush Administration responded in a letter from Secretary of

Agriculture Mike Johanns to Senator Saxby Chambliss and Representative Bob

Goodlatte, the respective agriculture committee chairs, assuring the industry that the

CAFTA-DR would not be allowed to interfere with the operation of the sugar

program as defmed in the Farm Security and Rural Investment Act of2002 (the Farm

Bill) through FY2007, when it expires. In particular, he agreed to act should

u For example, in the case of beef the Central American countries have agreed to the

immediate elimination of tariffs on U.S. prime and choice cuts, but have a 15-year tariff

phase-out on other products, with a backloaded schedule (no tariff reductions in the early

years) and a safeguard. The United States has a 26% out-of-quota tariff on beef that will be

phased out over 15 years, with the quota schedule defined for each country.

36 USITC, U.S.-CentralArnerican-Dorninican Free Trade Agreement, p. 35.

Ibid., pp. 38-40.

CRS-21

additional sugar imports due to the CAFTA-DR, NAFTA, and other trade agreementscause the import trigger threshold of 1.532 million short tons per year to be exceededand threaten the sugar program operations. The U.S. Secretary ofAgriculture agreedthat in such a case, he would preclude entry of additional sugar imports into thedomestic sweetener market by either making direct payments to exporters or usingagricultural commodities to purchase sugar to be used for nonfood use (ethanolproduction). This offer also proved inadequate to bring about sugar industry supportfor the CAFTA-DR.

Increasing grain exports was another important goal for the United States.Wheat is not grown in the CAFTA-DR countries and there is already largely freetrade in this commodity. Staples for the CAFTA-DR countries, such as rice andwhite corn, however, remain protected and there is a complicated system for phasingout TRQs on U.S. exports over a 15-20 year period. As with sugar imports to theUnited States, U.S. exports of corn and rice will increase slowly due to the highlyrestrictive TRQs and special safeguard measures. The USITC estimates that changesin the quantity of exports from the United States will be small at first and rise byperhaps 20% by the end of the TRQ phase-out period. The USITC suggests that thelong-run effect may be small (1.2% of total U.S. grain exports), but notes that the“potential increase in grains exports offers significant market opportunities for U.S.white and yellow corn growers and U.S. rice growers.”38

Despite the lengthy transition period toward freer trade under the CAFTA-DR,concerns remain over the potentially harmful effects to Central America, particularlyto the small commercial and subsistence farmers, of further opening its markets toU.S. agriculture.39 Three recent studies, however, agree that overall, increasedagricultural trade can also be one source of Central American rural development. Inaddition to increasing Central American agricultural exports, the majority ofhouseholds are net consumers of agricultural goods, and so stand to gain from lowerprices, the equivalent to an increase in family income. Because subsistence farmers’produce generally does not reach the market, they are unlikely to be affected greatlyby changes in market prices.40

Still, for the minority of rural net producers of agricultural goods, economistsalso agree that adjustment policies are essential, beginning with targeted incomeassistance. For rural areas to benefit fully from the CAFTA-DR, there is also acritical need for increased investment in transportation and communications

38 Ibid., pp. 43-47.

39Oxfam International. A Raw DealforRice Under CAFTA-DR. Briefing Paper #68. 2004.40 Todd, Jessica, Paul Winters, and Diego Arias. CAFTA and the Rural Economies ofCentral America: A Conceptual Franeworkfor Policy and Program Recommendation.Inter-American Development Bank. Washington, D.C. December 2004. pp. 43-50, Mason,Andrew D. Ensuring that the Poor Benefitfrom CAFTA: Policy Approaches to Managingthe Economic Transition. Draft of Chapter 5 in forthcoming book. The World Bank.Washington, D.C. March 25, 2005. pp. 25-26, 35, and Arce, Carlos and Carlos FelipeJaramillo. El CAFTA y la Agriclutura Centroamericana. Paper presented at the WorldBank Regional Conference on International Trade and Rural Economic Development,Guatemala. February 21-22, 2005. p. 17.

CRS-22

infrastructure, education, and more fully developed financial services. This will

improve agricultural productivity, help transition workers toward alternative crops

or non-farm employment, and integrate the rural economy more fully with the

national and international economy. Without concerted effort in adjustment

assistance, the poorest segments of rural Central America may remain vulnerable to

the negative effects of freer trade.4

Investment

In 2003, the United States’ stock of foreign direct investment (FD1) in the

CAFTA-DR countries was $4.3 billion, which represents only 1.4% of U.S. FDI in

Latin America and the Caribbean. Some 43% of the FDI in CAFTA-DR countries

went to Costa Rica, followed by the Dominican Republic with 20%. The United

States has advocated clear and enforceable rules for foreign investment in all trade

agreements, which is largely accomplished by “standard” language requiring national

and most-favored-nation (nondiscriminatory) treatment. The CAFTA-DR clarifies

rules on expropriation and compensation, investor-state dispute settlement, and the

expeditious free flow ofpayments and transfers related to investments, with certain

exceptions in cases subject to legal proceedings (e.g., bankruptcy, insolvency,

criminal activity). Transparent and impartial dispute settlement procedures provide

recourse to investors.

Two investment issues stood out. First, an investor-state provision, common in

U.S. bilateral investment treaties (BITs) and used in earlier FTAs, was included. It

allows investors alleging a breach in investment obligations to seek binding

arbitration against the state through the dispute settlement mechanism defined in the

Investment Chapter. U.S. investors have long supported the inclusion of investor-

state rules to ensure that they have recourse in countries that do not adequately

protect the rights of foreign investors. Since bilateral investment treaties are usually

made with developing countries that have little foreign investment in the United

States, such a provision was not thought to be applied to the United States.

Circumstances changed, however, under NAFTA when Canada used investor-state

provisions to raise “indirect expropriation” claims against U.S. state environmental

regulations.42

Although none of the claims filed against the United States has prevailed,

Congress instructed in TPA legislation that future trade agreements ensure “that

foreign investors in the United States are not accorded greater substantive rights with

respect to investment protections than United States investors.” In response, Annex

10-C ofthe CAFTA-DR states that “except in rare circumstances, nondiscriminatory

regulatory actions by a Party that are designed and applied to protect legitimate

welfare objectives, such as public health, safety, and the environment, do not

constitute indirect expropriations.” This provision and one that allows for early

‘ ibid.42 Indirect expropriation refers to regulatory and other actions that can adversely affect a

business or property owner in a way that is “tantamount to expropriation.” This issue and

many cases are discussed in CRS Report RL3 1638, Foreign Investor Protection Under

NAFTA Chapter 11, by Robert Meltz.

CRS-23

elimination of“frivolous” suits were intended to address congressional concerns, butthere is uncertainty about how well the changes will operate.

Second, the CAFTA-DR countries requested greater flexibility in the treatmentof certain sovereign debt. Annex 10-A allows sovereign debt owed to the UnitedStates that has been suspended and rescheduled not to be held subject to the disputesettlement provisions in investment chapter, with the exception that it be givennational and MFN treatment. Annex 10-E extends from six months to one year theamount of time required before a U.S. investor may seek arbitration related tosovereign debt with a maturity of less than one year. Both provisions are intended,in the event of a financial crisis, to keep the CAFTA-DR from interfering in anysovereign debt restructuring process, and are viewed by the U.S. Treasury as anaccommodation to Central American interests.

Services

The United States is the largest services exporter in the world and services tradepresented a number of hurdles given that the Central American countries haveadopted few commitments of the WTO ‘s General Agreement on Trade in Services(GATS). There were also many industry-specific barriers that existed, such as:barriers to foreign insurance companies in Guatemala; “heavy” regulation licensingof foreign professionals in Honduras; local partner requirements in some financialservices in Nicaragua; and numerous services monopolies in Costa Rica (insuranceand telecommunications).43 The CAFTA-DR provides broader market access andgreater regulatory transparency for most industries including telecommunications,insurance, financial services, distribution services, computer and business technologyservices, tourism, and others. Banks and insurance firms have full rights to establishsubsidiaries, joint ventures, and branches. Regulation of service industries isrequired to be transparent and applied on an equal basis and e-commerce rules areclearly defined, a critical component of delivering services.’

The USITC suggests that the CAFTA-DR will have little effect on U.S. servicesimports because the market is already open. It does anticipate opportunities for U.S.firms to expand into Central America. In particular, Costa Rica agreed to theeventual opening ofits state-run telecommunications and insurance industries, wherethere has been strong political resistence to privatization and deregulation.45 Unlikethe other countries, doing so will constitute a major structural adjustment for theCosta Rican economy, will have implications for Costa Rican social policy, and willrequire amending domestic laws, all ofwhich, the Costa Ricans argued, was difficultfor their legislature to support if they did not receive concrete tradeoffs in other areas,such as agriculture and textiles. Negotiators resolved these issues in two week-longdiscussions held in January2004 and their detailed conunitments are presented in therelevant chapters ofthe CAFTA-DR. Because ofthis continued sensitivity, however,

USTR. 2004 National Trade Estimate Report on Foreign Trade Barriers. Washington,D.C. 2004.

44USTR, CAFTA Summary, p. 2-3.‘ Salazar-Xirinachs and Granados, op. cit., p. 260.

CRS-24

a vote on ratifying the CAFTA-DR is highly controversial in the Costa Rican

Congress.

Government Procurement

None of the CAFTA-DR countries is a signatory to the WTO Agreement on

Government Procurement and complaints against purchasing processes vary from

dissatisfaction with opaque and cumbersome procedures in Costa Rica to outright

corruption in Guatemala. El Salvador, Nicaragua, and Honduras passed new

government procurement laws in 2000/01, and in general, there have been

improvements in all countries in dealing with project bidding, although transparency

issues remain.46 Some analysts believe this is due in part to a lack of incentives given

that many of these countries will not be able to compete in the U.S. government

procurement market.47

The CAFTA-DR grants non-discriminatory rights to bid on contracts from

Central American ministries, agencies, and departments, with the exception of“low

value contracts” and other exceptions. It also calls for procurement procedures to be

transparent and fair, including clear advance notices of purchases and effective

review. Specific schedules detailing exceptions and limitations were written by each

country, covering such diverse issues as the sale of firearms to supplying school

lunch programs. In addition, each country provided a list ofsubnational governments

(e.g., states and municipalities) that agree to adhere to the government procurement

provisions. The CAFTA-DR also makes clear that bribery is a criminal offense

under the laws of all countries. In general, the provisions are supported by U.S.

businesses interested in doing or expanding opportunities in the region.48

InteiJectual Property Rights

All Central American countries are revising, or have revised, their intellectual

property rights (IPR) laws and are closing in on complying with the WTO Agreement

on Trade-Related Aspects of Intellectual Property Rights (TRIPS). That said, all

countries are subject to criticism for falling short of either clarifying or enforcing

penalties for noncompliance and in some cases have simply not adopted reforms that

many U.S. industries (e.g., sound and video recordings, pharmaceuticals, book

publishing, computer software) consider necessary to protect their intellectual

property. Piracy, incomplete or inadequate legal protection, and enforcement

capacity remain problems and ongoing concerns exist across the range of IPR issues

ofpatents, trademarks, and copyrights, covering print, electronic, and other media.49

The IPR provisions in the CAFTA-DR go beyond those in the WTO. They

provide that all businesses receive equal treatment and that the CAFTA-DR countries

ratify or accede to various international P agreements. Trademarks benefit from a

46 USTR, 2004 National Trade Estimate Report on Foreign Trade Barriers.

Salazar-Xirinachs and Granados, op. cit., p. 253.

48USTR, AFTA Summaty, p.5.‘ Ibid and 2004 National Trade Estimate Report on Foreign Trade Barriers.

CRS-25

transparent online registration process and special system to resolve disputes overinternet domain issues, among other benefits. Copyright provisions clarify use ofdigital materials (exceeding TRIPS standards) including rights over temporary copiesof works on computers (music, videos, software, text), sole author rights for makingtheir work available online, extended terms of protection for copyrighted materials,strong anti-circumvention provisions to prohibit tampering with technologies, therequirement that governments use only legitimate computer software, the prohibitionof unauthorized receipt or distribution of encrypted satellite signals, and rules forliability of internet service providers for copyright infringement. Patents and tradesecrets rules confonu more closely with U.S. norms. End-user piracy is criminalizedand all parties are required to authorize the seizure, forfeiture, and destruction ofcounterfeit and pirated goods. The CAFTA-DR also mandates statutory damages forabuse of copyrighted material.50

The CAFTA-DR goes a long way toward meeting U.S. business IPR protectionneeds and the USITC suggests that many industries will benefit from higher revenueif the new standards can be enforced. Even if laws are changed to conform to theCAFTA-DR commitments, however, enforcement issues will likely remain andtechnical assistance may be needed to help develop the necessary capabilities.51

Pharmaceutical Data Protection. To bring a patented drug to market, adrug company must demonstrate through clinical trials that the drug is safe andeffective. Under U. S. patent law, the data used to establish these claims are protectedfrom use by generic manufacturers for five years from the time the drug is introducedin a country’s market. Similar language was adopted in the JPR chapter of theCAFTA-DR. This provision became controversial in November 2004 when theGuatemala legislature changed its laws, adopting World Trade Organization (WTO)language that would have limited data protection to five years from the time a drugis brought to market in the first country (e.g., the United States), rather than from thepresumably later time that it might be introduced in a second country (e.g.,Guatemala).

The USTR argued that this change was a breach of the CAFTA-DRcommitments and threatened to delay implementing legislation until the law waschanged. Guatemala reversed the data protection law, to the disappointment ofmanywho argued that the CAFTA-DR provisions could delay access to future genericdrugs. Given that data protection and patent protection often run concurrently,however, it is debatable whether the introduction of future generic drugs will befurther inhibited by this provision. An August 5, 2004 side agreement among allsignatories further clarifies that “obligations” under Chapter 15 of the CAFTA-DRdo not affect a country’s ability “to take necessary measures [e.g., compulsorylicensing for generic drugs] to protect public health by promoting access to medicinesfor all,” in particular those needed to combat epidemics such as H1V/AIDS,tuberculosis, and malaria, among others. Critics, however, would have preferred that

° Ibid., p. 4-5.51 USITC, U.S.-Central America-Dominican Republic Free Trade Agreement, p. 101.

CRS-26

the side agreement include an explicit exception to the data protection requirement

for cases where compulsory licencing under the WTO rules might be invoked.52

Labor and Environment

Perhaps the greatest challenge to the CAFTA-DR arose over concerns about the

labor and environment chapters. It has become widely accepted that labor and

enviromuent provisions should be part of modern trade agreements. There is

considerable disagreement, however, over how aggressive language in trade

agreements should be in addressing these issues.

From an economic perspective, labor and environment advocates in the United

States argue that developing countries may have an “unfair” competitive advantage

because their lower standards are the basis for their lower costs, which in turn are

reflected in lower prices for goods that compete with those produced in developed

countries.53 It follows from this argument that the difference in costs is an enticement

to move U.S. investment and jobs abroad. On the other hand, economists have

argued that developing countries have a comparative advantage in labor costs

consistent with the free trade model and studies suggest that these cost differentials

are usually not high enough to determine business location alone productivity

remains the primary decision factor.54 Further, many economists view trade

liberalization as part of the overall development process that, in and off itself, can

promote social change.55 Developing countries are also concerned with sovereignty

52 U.S. Congress. House of Representatives. Committee on Ways and Means. Dominican

Republic-Central America-United States Free Trade Agreement Implementation Act.

H.Rept. 109-182. PP. 50-51. The side agreement is available at [http://www.ustr.govj and

for a summary of the debate, see Brevetti, Rosella. CAFTA Opponents Blast U.S. Stance

on Guatemalan Data Protection Law. International Trade Reporter. BNA, Inc. March 10,

2005. See also: CRS Report RS2 1609, The WTO, Intellectual Property Rights, and the

Access to Medicines Controversy, by Ian F. Fergusson.

The difference is that in most developing countries, the social costs associated with

environmental degradation, pollution, and poor working conditions may not be captured in,

or are extemal to, the market price (so-called external costs). Through legal, regulatory, and

tax measures, developed countries require that businesses correct, or pay for, many ofthese

social problems, thereby internalizing these costs to the business, where they are then

reflected in the final (relatively higher) price of the good or service in the market place.

See Stem, Robert M. Labor Standards and Trade. In: Bronckers, Marco and Reirihard

Quick, eds. New Directions in International Economic Law: Essays in Honor ofJohn H.

Jackson. The Hague: Kiuwer Law International. 2000. pp. 427-28 and 436 and CRS

Report 98-742, Trade with Developing Countries: Effects on US. Workers, by J.F.

Hornbeck. Productivity and wage levels are, however, highly correlated. See Rodrik, Sense

and Nonsense in the Globalization Debate, pp. 30-33.

In addition to the external costs addressed in this section, it is interesting to note that there

is some broader evidence that FTAs have not “forced a race to the bottom of regulatory

standards,” but to the contrary, that policy convergence is affected more by countries

agreeing to “norms of governance” via cooperation through international agreements. See

Drezner, Daniel XV. Globalization and Policy Convergence. International Studies Review.

Vol. 3, Issue 1, Spring 2001. pp. 75 and 78.

CRS-27

issues related to specifying standards in trade agreements and the possibility that theycan be misused as a disguised form of protectionism.

Labor Issues. The labor chapter proved to be the biggest point of contentionin the CAFTA-DR debate, divided largely along party lines. The opening paragraphof the chapter states that all parties reaffirm their commitments under the UnitedNations International Labor Organization (ILO). These are defined in the ILO ‘5 1998Declaration on Fundamental Princzples and Rights at Work as: (1) the freedom ofassociation and the effective recognition of the right to collective bargaining; (2) theelimination of all fonris of forced or compulsory labor; (3) the effective abolition ofchild labor; and (4) the elimination of discrimination in respect of employment andoccupation.56 Disagreement revolved around three issues. First, whether theCAFTADR countries had laws that complied with ItO basic principles. Second, theability of these countries’ to enforce their laws. Third, and most importantly,capacity of the CAFTA-DR Labor Chapter to compel legal compliance andenforcement of ILO fundamental principles.

CAFTA-DR Labor Laws and Enforcement. The Central Americancountries entered the debate early when they requested the ILO to conduct a study oftheir labor laws. The final 2003 report is subject to interpretation and has been usedto bolster both sides of the argument as to whether the CAFTA-DR countriesguarantee core ILO principles.57 Some interpreted the report to affirm that theCAFTA-DR countries’ laws comply with internationally recognized labor standards.In response, Democratic Members ofthe House Ways and Means Committee pointedout deficiencies in many of their laws in a letter sent to the USTR’s office. Itidentified 20 Central American laws that fail to meet core ILO principles, all casesrelated to freedom of association or collective bargaining, as opposed todiscrimination, compulsory labor, or child labor.58

In April2005, with the assistance ofthe litter-American Development Bank, theCAFTA-DR country ministers of trade and labor released a study of their countries’shortfalls in meeting and enforcing core labor principles. Although it documentedthat all countries had made recent changes to their labor laws, there was clearrecognition for the need to hannonize some laws better with ILO principles, as wellas, address enforcement of key infractions such as employment discrimination

56Article 16.8 of the Labor Chapter also has a list of internationally recognized labor rightsthat includes all ofthese rights plus “acceptable conditions ofwork with respect to minimumwages, hours of work, and occupational safety and health.”

United Nations. International Labor Organization. Fundamental Principles and Rightsat Work: A Labour Law Study: Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua.Geneva, 2003.58 Letter to the Honorable Peter Allgeier. April 4, 2005. If Honduras and Guatemala areeliminated, concerns in this letter would focus on the use of solidarity associations, onerousstrike requirements, and inadequate protection against anti-union discrimination.

CRS-28

(pregnancy testing), abuses in free trade zones (application of labor laws), and the

need to dedicate more resources to enforcement.59

The debate over the adequacy of labor laws was not resolved to the satisfaction

of any party, but there was little disagreement that labor law enforcement is an

ongoing problem and that unionization is not widespread. The CAFTA-DR countries

have admitted in their own report that many lack the financial resources and technical

expertise to enforce adequately good labor practices, a problem that will also take

time and resources to overcome.

Labor Provisions in TPA and the CAFTA-DR. The Labor Chapter in the

CAFTA-DR defines certain labor standards for all member countries and the dispute

settlement mechanism for arbitrating formal complaints against noncompliance. It

closely follows language set out in Trade Promotion Authority (TPA) legislation on

the principal negotiating objectives of the United States with respect to labor.6° The

USTR made note of this fact and further argued that the chapter goes beyond earlier

FTAs through a Labor Cooperation and Capacity Building Mechanism that will

support a mutual approach to improve working conditions in CAFTA-DR countries

by: (1) ensuring effective enforcement of existing labor laws; (2) working with the

ILO to improve existing labor laws and enforcement; and (3) building local capacity

to improve workers rights.

Critics charged, however, that the CAFTA-DR labor provisions were too weak

because they give different weight to the following three provisions: (1) the effective

enforcement of domestic labor laws; (2) the reaffirmation of commitments to ILO

basic principles; and (3) “non-derogation” from domestic standards (not weakening

or reducing protections to encourage trade and investment).6’The first provision,

failure to enforce domestic labor laws, can be formally challenged in the dispute

resolution process as defined in the CAFTA-DR. Dispute resolution is not available

for the other two provisions, although they are supported in principle (Articles 16.2

and 16.6).

There was also concern over the differences between labor and other dispute

settlement provisions. If a commercial dispute remains unsettled, the country faces

the possibility of a suspension of benefits “of equivalent effect” (Article 20.16),

resulting in the raising of tariffs, or payment of a monetary assessment (fine) equal

to 50% ofwhat a dispute panel determines is “of equivalent effect.” This article does

not apply to the disputable labor provision. The difference is that the option for

Ministers of Trade and Labor. The Labor Dimension in Central America and the

Dominican Republic. Building on Progress: Strengthening Compliance and Enhancing

Capacity. April 2005.

60 The TPA vote, however, was highly contentious in part because of the disagreement over

how the principal negotiating objectives with respect to labor were defined.

61 Labor Advisory Committee for Trade Negotiations and Trade Policy (LAC). The U.S.

CentralAn2erica Free Trade Agreement. March 19,2004. p. 6, and Lee, Thea M. Assistant

Director for International Economics, AFL-CIO. Comments on the Proposed US-Central

American Free TradeAgreement, before the USTR Trade Policy Committee, November 19,

2002.

CRS-29

failing to resolve a labor dispute is a monetary assessment paid by the country, whichis capped at $15 million per year, per violation, with recourse to an equivalent dollarvalue of suspended benefits (higher tariffs) if the fine is not paid. The fine is paidinto a fund and expended for “appropriate labor initiatives.”

An Enforceable Labor Chapter. U.S. labor advocates have charged that“the labor provisions of the CAFTA-DR will not protect the core rights of workersin any of the six countries participating in the agreement.”62 Many Members ofCongress concurred, believing that the “enforce your own laws” standard, as well asthe limited dispute settlement provisions, will be ineffective at compelling countriesto meet basic ItO standards. It was also argued that they are a step backward fromthe provisions allowing for the suspension of trade benefits found in U.S. unilateralpreferential trade arrangements, such as the Caribbean Basin Initiative (CBI) and theGeneralized System ofPreferences (GSP). In these, the United States has the optionto suspend trade benefits (reimpose tariffs) if a country does not comply withprovisions of the agreement, including the labor section. Democrats cited a numberof examples, including CAFTA-DR countries, where sanctions, or threats thereof,compelled changes in labor laws 63 Further, capping the assessment in a labor disputeat $15 million and having the assessment paid into a fund in the offending countrywas seen as a largely ineffective mechanism for compliance.

Supporters ofthe Labor Chapter argued that the agreement encourages countriesto improve their laws, making the “enforce your own laws” a meaningful standard,that the CBI option for trade sanctions is less appealing in a reciprocal free tradeagreement where the United States is also subject to the discipline, and further, thattrade sanctions are a “blunt” instrument, punishing all export workers whose productswould come under the sanctions, potentially worsening their situation rather thanimproving it. It was also argued that sanctions have not been a widely used tool overthe lives of the CBI and GSP programs, and to the contrary, that an annual $15million fine per violation is a potentially significant deterrent for the CAFTA-DRcountries. Finally, technical assistance, cooperation, and transparency were presentedas more effective tools in the long run to bring about change in Central America.64

Only time will tell if the CAFTA-DR labor provisions provide support andpossibly effective punitive responses to encourage deeper labor rights reforms inCentral America. These provisions are similar to those found in other FTAs forwhich Congress passed implementing legislation, including Chile, Singapore,Morocco, and Australia (Jordan’s labor provisions were different in some places).Many Members may have accepted that those countries had adequate labor laws,even if there were enforcement or other concerns. This perception was clearlylacking for the CAFTA-DR countries, despite efforts to make transparent theirdeficiencies and to correct some laws and enforcement problems. Hence, broader

62 LAC, ibid., p. 1.63 See U.S. Congress. House of Representatives. Committee on Ways and Means.Dominican Republic-CentralAinerica- Un itedStates Free Trade AgreementlmplementationAct. H.Rept. 109-182. pp. 47-50.

64Ibid., pp. 4-6. See also: Gresser, Edward. The Progressive Casefor CAFTA. ProgressivePolicy Institute. Policy Brief. July 2005. pp. 4-6.

CRS-30

support was never reached in Congress over the adequacy of these provisions in the

CAFTA-DR.65

Environmental Issues. Maj or goals included protecting and assuring strong

enforcement ofexisting domestic environmental standards, ensuring that multilateral

enviromnental agreements are not undermined by trade rules, promoting strong

enviromnental initiatives to evaluate and raise enviromnental performance,

developing a systematic program of capacity-building assistance, and assuring that

environmental provisions in FTAs are subject to the same dispute resolution and

enforcement mechanisms as are other aspects of the agreement.66

The USTR argued that congressional objectives on environmental issues have

been met in the proposed CA.FTA-DR agreement. It includes language requiring all

countries to enforce their laws and regulations and also creates an environmental

cooperation agreement with a framework for establishing a cooperation commission

and a process to conduct capacity building. All parties agree to commit to establish

high levels ofenvironmental protection and to open proceedings in the administration

and enforcement of laws and regulations.67

Advocates raised the issue of the environmental effects of trade, particularly in

developing countries that may have weak laws and lax enforcement mechanisms, but

the environmental provisions were not the most contentious issues in the CAFTA

DR. Many of these same advocates have conceded that trade agreements have not

led to catastrophic pollution problems nor encouraged a “regulatory race to the

bottom.” In fact, there has also been a certain acknowledged degree of success, by

having environmental issues addressed in the body of FTAs, in side agreements on

environmental cooperation, and through technical assistance programs, the latter of

which developing countries can use to respond to specific problems. Advocates still

noted that much can be improved, such as tightening enforcement language and

ensuring that the United States allocates financial resources to back up promises of

technical assistance, particularly in the case of Central America, where commitment

to “public accountability” is questioned in some cases.68

The Trade and Environment Policy Advisory Committee supported most of the

environment provisions in the CAFTA-DR and particularly the enhanced public

participation process negotiated by the State Department in a side agreement. The

65 Indeed, incorporating mandatory adherence to the ILO basic principles would later

become standard language for the Peru, Panama, and Colombia bilateral FTAs.

66 [http://www.sierraclub.org/trade/fasttrack/letter.asp], Principlesfor Environmentally

Responsible Trade. Another important issue for the United States is ensuring that its higher

environmental standards defined in law and regulation not be compromised by challenges

of protectionism. See CRS Report RL3 1638, Foreign Investor Protection Under NAFTA

Chapter 11, by Robert Meltz.

67 For more details on congressional interest in environmental provisions in trade

agreements, see CRS Report RS2 1326, Trade Promotion Authority: Environment Related

Provisions in P.L. 107-210, by Mary Tiemann.

68 See Audley, John. Environment and Trade: The Linchpin to Successful C’AFTA

Negotiations? Carnegie Endowment for International Peace. Washington, D.C. July2003.

CRS-31

dispute settlement provisions, effectively the same rules governing labor disputes,were accepted as striking the “proper balance.” The advisory committee still raiseda number of specific environmental concerns, and questioned whether the CAFTADR would be able to meet congressional objectives on capacity building withoutconcrete funding for the program.69 In response, the seven countries signed asupplemental Environmental Cooperation Agreement (ECA) on February 18, 2005.It calls for a new unit to be established in the Secretariat for Central AmericanIntegration to administer public submissions or complaints made on enforcementissues. The ECA is intended to address both short- and long-term environmentalgoals, including providing for a monitoring process, but does not address concernsover funding for the implementation of environmental initiatives.

Dispute Resolution and Institutional Issues

The dispute resolution chapter was modeled on previous FTAs, in whichdisagreements are intended to be resolved cooperatively via a consultative process.If this approach is not successful, the process moves to the establishment of the FreeTrade Commission of cabinet-level representatives, and finally an arbitral panel.Arbitral panels are intended to broker mutually acceptable resolutions, includingproviding for compensation, if appropriate. If a mutually-agreed solution is notfound, the complaining party may resort to a suspension of benefits of equivalenteffect. This result may also be challenged, and final resolution, as well as how thesuspension of benefits are to be administered are set out in guidelines. Resolvinglabor and environmental disputes will be handled slightly differently (see previoussection). All dispute resolution procedures are defined in Chapter 20.Administrative and other technical matters (e.g., transparency issues) of tradeagreement implementation were also addressed by this working group.

Trade Capacity Building

Even before detailed discussions began on the CAFTA-DR, the CentralAmerican countries were apprehensive over the possibility ofbeing overwhelmed bythe resource and experience advantage that the United States had to negotiate andcomply with liberalized trade rules. Hence, the need for trade capacity building,which may be classified into three distinct areas beyond trade negotiationcapabilities. First, the ability to identify priorities, including where the majoradjustment costs (losers) are expected to be and how to respond to them. Second, theability to develop resources to implement the agreement, including institutional,financial, and analytical resources. Third, the capacity to benefit from the CAFTADR.7° The agreement created a permanent Committee on Trade Capacity Buildingto continue work begun in the negotiation process, and recommendations in theagreement call for one of its first priorities to be customs administration.

69 Trade and Environment Policy Advisory Committee on the Central American Free TradeAgreement. The US. -Central American Free Trade Agreement. March 12, 2004.

70This typology of capacity issues was developed by Bernard Hoekman ofthe World Bank.Earlier versions of this report mentioned a fourth area, trade negotiation capacity.

CRS-32

The third category, however, is arguably the most challenging. It refers to the

ability of a business to: compete in a larger market; learn how to export and use

imports (as inputs) more to its advantage; tap into global finance; navigate customs

and trade logistics problems; and in other ways make the transition from local

producer to international player.71 This will be a difficult challenge for many Central

American firms, particularly if barriers to world trade are reduced outside the U.S.-

Central American relationship (WTOIFTAA) putting increasing pressure on

marginally productive businesses. The joint-production relationship already

established in textiles and garments suggests that certain finns have already

developed some expertise in meeting these challenges.

From the outset of negotiations, the United States advocated assisting the

Central American countries. Each Central American country prepared a National

Action Plan based on a review of its “trade-related” needs. Assistance is being

provided by the United States government through the U.S. Trade and Development

Agency, Agency for International Development, and the Department of State, among

others; private groups (corporate and non-government organizations NGO5); and

five international organizations (the Inter-American Development Bank — 1DB,

Central American Bank for Economic Integration — CABEI, United Nations

Economic Commission on Latin America and the Caribbean — ECLAC,

Organization of American States — OAS, and the World Bank).

The CAFTA-DR includes a Committee on Trade Capacity Building to

coordinate these types ofactivities. U.S. inter-agency flmding in support ofCAFTA

DR trade capacity building peaked as the agreement came to completion, including

$20 million for labor and enviromnental technical assistance in the FY2005 budget.

Maintaining formal support for these programs, including ongoing financial

commitments, is one challenge supporters of these programs emphasize. This is also

true for the trade capacity building efforts in specific non-commercial areas, such as

enforcing labor and environmental commitments.

71 Ibid.

CRS-33

Appendix 1. Chronology of CAFTA-DR Negotiations

DateJanuary 16, 2002

August 6, 2002

October 1, 2002

November 19, 2002

January 27, 2003

August 4, 2003

December 17, 2003

January 5-9, 2004

January 12-16, 2004

January 19-24, 2004

January 25, 2004

January 28, 2004

February 20, 2004

March 15, 2004

March 24, 2004

April 9, 2004

May 28, 2004

August 5, 2004

December 17, 2004

March 3, 2005

March 10, 2005

April 13, 2005

MilestonePresident George W. Bush announces his intention to explorea free trade agreement (FTA) with Central America.

President Bush signs the Trade Act of 2002 (P1.107-210),which includes Trade Promotion Authority (TPA).

President Bush, as required under TPA, fonnally notifiesCongress of his intention to negotiate a U.S.-Central AmericaFree Trade Agreement (CAFTA) with Guatemala, El Salvador,Honduras, Costa Rica, and Nicaragua.

USTR holds public hearings on CAFTA.

The first of nine rounds begins in San Jose, Costa Rica.

USTR Zoellick formally notifies Congress of intent tonegotiate an FTA with the Dominican Republic.

CAFTA negotiations conclude in Washington, DC. CostaRica requests further negotiation on telecommunications,insurance, agriculture, and textile market access issues.

Costa Rica and the United States hold first round of bilateraldiscussions on CAFTA.

First round of negotiations with Dominican Republic held.

Costa Rica and United States hold second round of bilateraldiscussions on CAFTA.

Costa Rica and United States agree to CAFTA provisions.

USTR releases draft version of CAFTA to public.

President Bush formally notifies Congress of his intention tosign CAFTA.

The United States and the Dominican Republic conclude abilateral FTA and the USTR announces it will be “docked” toCAFTA.

President Bush formally notifies Congress of his intention tosign the U.S.-Dominican Republic FTA.

USTR releases draft text of the FTA with the DominicanRepublic.

The USTR and trade ministers from the Central Americancountries sign CAFTA in Washington, D.C.

The USTR and trade ministers from the Dominican Republicand Central America sign the CAFTA-DR agreement inWashington, D.C.

Salvadoran legislature ratifies the CAFTA-DR 49 to 35.

Honduran legislature ratifies the CAFTA-DR 100 to 28.

Guatemalan legislature ratifies the CAFTA-DR 126-12.

Senate Finance Committee holds hearing on CAFTA-DR.

CRS-34

Date Milestone

April 21, 2005 House Ways and Means Committee holds hearing on CAFTA

DR.

June 14, 2005 Senate Finance Committee holds “mock markup” on draft

implementing legislation and informally approves it 11 to 9,with one non-binding amendment.

June 15, 2005 House Ways and Means Committee holds “mock markup” on

draft implementing legislation, informally approving it 25 to

16 with one non-binding amendment.

June 23, 2005 President Bush sends final text and required supporting

documents of the CAFTA-DR implementing bill to Congress.

June 23, 2005 Identical legislation is introduced in the House and Senate as

H.R. 3045 and S. 1307.

June 29, 2005 Senate Finance Committee orders S. 1307 favorably reported

by voice vote, with no written report.

June 30, 2005 House Ways and Means Committee orders H.R. 3045

favorably reported by a roll call vote, 25 to 16.

June 30, 2005 S. 1307 agreed to in the Senate, 54 to 45.

July 25, 2005 H.R. 3045 reported by the House Committee on Ways and

Means (H.Rept. 109-182).

July 26, 2005 House Committee on Rules provides a closed rule for

consideration of H.R. 3045 under which debate is limited to

two hours and all points oforder against consideration of H.R.

3045 are waived (H.Rept. 109-186).

July 28, 2005 H.R. 3045 agreed to in the House, 217 to 215.

July 28, 2005 Senate agrees to substitute H.R. 3045 for S. 1307, 56 to 44.

August 2, 2005 President Bush signs H.R. 3045 into law (P.L. 109-53; 119

Stat. 462)

September 6, 2005 Dominican Republic ratifies CAFTA-DR. Chamber of

Deputies passes bill 118 to 4, Senate passed bill 27 to 3 on

August 26.

October 9, 2005 Nicaraguan General Assembly ratifies CAFTA-DR by a vote

of49 to 37.

March 1, 2006 The United States implements CAFTA-DR for El Salvador.

April 1, 2006 The United States implements CAFTA-DR for Honduras and

Nicaragua.

July 1, 2006 The United States implements CAFTA-DR for Guatemala.

March 1, 2007 The United States implements CAFTA-DR for the Dominican

Republic.

October 7, 2007 Costa Rica referendum supports CAFTA-DR 51.6% to 48.4%.

CRS-35

Appendix 2. Selected Economic Indicators(year 2003 data, except where otherwise indicated)

..- .‘. ‘4r 1 . . ..

. Costa El Guat. ion- ‘Jicar- Dom. Rica Salvador einala duras agua Rep.

GDP ($ billions) 17.5 14.7 24.0 6.8 2.7 20.5

GDP Growth (%) 5.0 2.2 2.4 1.5 2.3 -1.3

GDP Growth 1980- 3.0 0.2 0.8 2.7 -1.9 3.11990(%)*

GDP Growth 1990- 4.9 4.3 4.0 3.1 4.3 6.02002 (%)*

PPP Per Capita Gross 8,560 4,190 4,030 2,540 2,350 6,270National Income* *

Inflation (%) 9.3 2.8 5.5 9.8 6.1 28.0

Current Account -5.9 -4.5 -4.3 -7.6 -17.6 4.5Balance (% of GDP)

Pop. Below $1 per 2.0 31.1 16.0 23.8 45.1 <2.0day (%)***

HumanDevelopment 42 105 119 115 121 94Index (HDI) Rank#

Sources: World Bank, World Development Indicators 2004, pp. 14-15, 54-55, and 178-83, UnitedNations, Human Development Report 2003, and IMF website.* Average annual percent growth.* * Gross national income (GNI) converted to international dollars using purchasing power parity rates.An international dollar has the same purchasing power over the GNI as a U.S. dollar has in the UnitedStates. GNI, formerly represented as GNP by the World Bank, is a different, but similar measure asGDP. Data are for year 2002.

Percentage of population living on $1 per day or less, most recent survey year.# HDI is a composite measure (education, income, and life expectancy) of average achievement inhuman development. A lower ranking is better: e.g., United States (7), Italy (21), and South Korea(30). The 2003 report reflects data for year 2001.

CRS-36

Appendix 3. U.S. Merchandise Trade with CAFTA-DRCountries

(S mi11ions

. .

Country 1999 2000 2001 2002 2003 2004 Y,çiange bange4 1 2O03-200 l99-2004

U.S. Exports

CostaRica 2,381 2,460 2,502 3,117 3,414 3,304 -3.2% 38.8%

Honduras 2,370 2,584 2,416 2,571 2,826 3,077 8.9% 29.8%

Guatemala 1,812 1,901 1,870 2,044 2,263 2,548 12.6% 40.6%

El Salvador 1,519 1,780 1,760 1,664 1,821 1,868 2.6% 23.0%

Nicaragua 374 379 443 437 502 592 17.9% 58.3%

Dominican Rep 4,100 4,473 4,398 4,250 4,205 4,343 3.3% 5.9%

Total CAFTA 12.556 13,577 13,389 14,083 15,031 15,732 4.7% 25.3%

Mexico 86,909 111,349 101,2967 97,470 F 97,412 110,775 13.7% 27.5%

LAC* 55,153 59,283 58,1577 51,551 F 51,946 61,426 18.3% 11.4%

Latin America 142,062 170,632 159,453 L149,021L149,358 172,201 15.3% 21.2%

World 695,797 781,918 729,1001 693,103 724,771 817,936 12.9% 17.6%

U.S. Imports

Costa Rica 3,968 3,539 2,886 3,142 3,364 3,333 -0.9% -16.0%

Honduras 2,713 3,090 3,127 3,261 3,313 3,641 9.9% 34.2%

Guatemala 2,265 2,607 2,589 2,796 2,947 3,155 7.1% 39.3%

El Salvador 1,605 1,933 1,880 1,982 2,020 2,053 1.6% 27.9%

Nicaragua 495 589 604 679 770 991 28.7% 100.2%

Dominican Rep 4,287 4,383 4,183 4,169 4,455 4,528 1.6% 5.6%

Total CAFTA 15,333 16,141 15,269 16,029 16,869 17,701 4.9% 15.4%

Mexico 109,721 135,926 131,338 134,616 138,060 155,843 l2.9%L 42.0%

LAC* 58,464 73,348 67,370 69,503 78,829 98,749 25.3% 68.9%

LatinAmerica 168,185 209,274 198,708 204,119 216,889 254,592 17.4% 51.4%

World 1,024,618 1,218,022 1,140,999 1,161,366 1,257,121 1,469,671 16.9% 43.4%

U.S. Balance of Trade

Costa Rica -1,587 -1,079 -384 -25 50 -29

Honduras -343 -506 -711 -690 -487 -564

Guatemala -453 -706 -719 -752 -684 -607

El Salvador -86 -153 -120 -318 -199 -185

Nicaragua -121 -210 -161 -243 -268 -399

Dominican Rep -187 90 215 81 -250 -185

Total CAFTA -2,777 -2,564 -1,880 -1.947 -1,838 -1,969

Mexico 7 -22,812 [ -24,577 -30,042 7 -37,146 -40,648 -45.068

LAC* 7 -3,311 [ -14,065 -9,213 f -17,952 -26,883 -37,323

Latin America -26,124 [ -38,642 -39,2567 -55,098 -67,531 -82,391

World f •328,8T[ -436,104 - -41 l,8f -468,263 -532,350 -651,735

Source: Table created by CRS from U.S. Department of Commerce data.* Latin America and the Caribbean, except Mexico.

CAFTA-DR State Fact Sheets - Florida — Page 1 of 3

USDA United States Department of Agriculture Linkini VS. .\iLuf:uzForeign Agricultural Service

r

Home About Newsroom Data Commodities Trade Development Careers Contact Us Help

. You are here: Home / Publications / FAS Fact Sheets / CAFTA-DR I State Fact Sheets / Florida

STATE FACT SHEETS:Dominican Republic-Central America-United States Free Trade Agreement

El Search All USDA (CAFTA-DR)o Advanced Searcho Database-specific Searches Florida Farmers Will Benefit

May2005

Information for...

Exports of farm products help boost Florida’s farm prices and income. Such exports help supportMarket Development about 20,540 jobs both on and off the farm in food processing, storage, and transportation. InPrograms2003, Florida’s farm cash receipts were $6.5 billion, and agricultural exports were estimated at

Export U.S. Products $1.3 billion, putting its reliance on agricultural exports at 20 percent. Implementation of theDominican Republic-Central America-United States Free Trade Agreement (CAFTA-DR) willImport U.S. Productsincrease Florida’s exports of agricultural products.

Florida Benefits From the U.S.- CAFTA-DR Free Trade Agreement (FTA)

Despite over $1.6 billion in U.S. farm exports in 2003, CAFTA-DR countries continue to imposehigh tariffs and other barriers on most agricultural products, including Florida’s key exports. Aprimary U.S. objective was to change the “one-way-street” of duty-free access currently enjoyedby most CAFTA-DR exports into a “two-way-street” that provides U.S. suppliers with access tothese markets and levels the playing field with other competitors. This objective was achieved.Over 50 agricultural industry and farm groups, including the American Farm Bureau, support theFTA.

Fruits and Preparations. As the nation’s 2 largest exporter of fruit and fruit products, Florida fruitproducers and processors benefit from the FTA.

• Florida’s citrus growers, the source of nearly 30 percent of farm cash receipts, will benefitfrom the immediate elimination of duties on concentrated grapefruit juice by all CAFTA-DRcountries and on frozen concentrated orange juice by all Central American countries.Current duties on citrus can reach 20 percent in CAFTA-DR countries, and under WTO rules,could rise to as high as 60 percent. All duties in this sector will be eliminated within 15years, and earlier in many cases.

Vegetables and Preparations. Ranking in the nation in value of sales and 7th in exports, Floridavegetable producers and processors benefit from the FTA.

• Providing the 4th largest source of state farm cash receipts, Florida tomato growers benefitfrom elimination of duties affecting the nearly $500,000 in U.S. exports of fresh tomatoesin recent years. Current duties on tomatoes can reach 15 percent in CAFTA-DR countries,and under WTO rules, could rise to as high as 60 percent. All duties in this sector will beeliminated within 15 years, and earlier in many cases. As the hotel, restaurant, and foodservice sectors in the region continue to expand, along with increasing consumer incomesand seasonal production considerations, the United States will be well-positioned underCAFTA-DR to service the rising demand for fresh tomatoes.

Beef. As the state’s 5th largest source of farm cash receipts and 4th largest agricultural exportsector, Florida cattle and calve operators benefit from the FFA.

• Current import duties on U.S. beef exports are as high as 30 percent, and the WTO permitsduties as high as 79 percent.

• Duties on the products most important to the U.S. beef industry — Prime and Choice cuts —

will be eliminated immediately in Central American countries, while the Dominican Republicwill establish a zero duty TRQ of 1,100 metric tons which expands annually as duties are

htto ://www.fas.usda. gov/info/factsheets/CAFTAIfla. asn 11/10/2010

CAFTA-DR State Fact Sheets - Florida —

Page 2 of 3

eliminated.

• Some immediate duty-free access will be provided by certain countries on other beef cuts

through an initial TRQ totaling 1,165 metric tons, expanding annually until duties are fully

phased-out.

• Duties currently applied to other beef products and beef offals will be phased-out in S to 10

years.

• CAFTA-DR countries are working toward the recognition of the U.S. meat inspection and

certification systems in order to facilitate U.S. exports.

• The American Meat Institute, the National Cattlemen’s Beef Association, the National

Renderers Association, and the U.S. Meat Export Federation have expressed support

publicly for the CAFTA-DR PTA.

Dairy. As the state’s 6th largest source of farm cash receipts, Florida dairy operators benefit from

the FTA.

• U.S. dairy exporters currently face duties as high as 60 percent, and the WTO permits

duties as high as 100 percent.

• Each country will establish duty-free TRQs for certain dairy products totaling over 10,000

metric tons across the six countries — and each will receive the same level of TRQ access

for dairy products entering the United States.

• TRQs will grow by 5 percent per year for the Central American countries and 10 percent per

year for the Dominican Republic, with certain dairy products subject to safeguards during

the phase-out period.

• All Central American and Dominican duties will be eliminated within 20 years, with duties

on some dairy products eliminated earlier.

• The National Milk Producers Federation, the U.S. Dairy Export Council, the Grocery

Manufacturers of America, and the National Food Processors Association have expressed

support publicly for the CA PTA-DR FTA.

Sugar. The 0.3 percent of Florida farms engaged in sugar production will face no cuts in the over

100 percent out-of-quota duty on U.S. sugar that currently protects domestic producers.

• The United States will establish TRQ5 for CAFTA-DR countries, starting at 107,000 metric

tons. In the first year of implementation, increased market access in sugar will amount to

about 1.2 percent of annual U.S. sugar consumption. This amount grows very slowly by 2

percent a year into perpetuity, so that by year 15 of FTA implementation the increased

access on sugar (about 151,000 metric tons) amounts to about 1.7 percent of

consumption. The United States will also establish a quota for specialty sugar goods of

Costa Rica in the amount of 2,000 metric tons annually.

• Provisions will ensure only net surplus exporting countries in the region have access to the

new access, and provisions have been agreed to allow alternative forms of compensation to

be established to facilitate sugar stock management by the United States.

• The Sweetener Users Association, the National Confectioners Association, the Grocery

Manufacturers of America, and the National Food Processors Association have expressed

support publicly for the CA PTA-DR FrA.

Poultry. With nearly $200 million in farm cash receipts, Florida poultry producers benefit from the

FTA.

• U.S. poultry exporters currently face duties as high as 164 percent on both fresh and frozen

products, and the WTO permits duties as high as 250 percent.

• Each CAFTA-DR country will provide immediate duty-free access on chicken leg quarters, a

product where the United States is the world’s most competitive exporter, through country-

specific TRQ5 that expand annually as duties are eliminated in 17 to 20 years.

• Costa Rica and the Dominican Republic will establish duty-free TRQ5 for chicken leg

J,f,... i/w, £q c Quj nv/jnfn/factsheets/CAFTA/fla. asp 11 / 10/2010

CAFTA-DR State Fact Sheets - Florida— Page 3 of 3

quarters totaling 850 metric tons, each expanding by 10 percent annually. The other fourCentral American countries will establish a total regional duty-free TRQ of 21,810 metrictons (with individual country minimum quota levels). After year 12, the TRQ quantity will beno less than 5 percent of regional chicken production.

• Duties on poultry products such as wings, breast meat and mechanically de-boned poultrymeat will be reduced more quickly, with many eliminated within 10 years.

• CAFTA-DR countries are working toward the recognition of the U.S. meat inspection andcertification systems in order to facilitate U.S. exports.

• The National Chicken Council, the USA Poultry and Egg Export Council, and the NationalTurkey Federation have expressed support publicly for the CAFTA-DR FTA.

Sugar Production in Florida - Map (.pdf)

Return to CAFTA-DR State Fact SheetsPage Last Updated: September 27, 2007

FAS Home USDA.gov Economic Research Service (ERS) I World Agricultural Outlook Board (WAOB) I Trade Links FOIAAccessibility Statement I Privacy Policy I Non-Discrimination Statement I Information Quality I USA.gov I White House I Site Map

http://www.fas.usda.gov/info/factsheets/CAFTA/fla.asp 11 / 10/2010

CARIBBEAN TAX

HAVENS, MONEY

LAUNDERING

AND THE PUSH BACK

FROM THE US

2

Paradise

Lost?

Offshore

Financial

Havens

andM

oneyL

aundering

INT

RO

DU

CT

ION

Sincetheir

inception,offshore

centreshave

beenused

bylegitim

atefinancial

institutionsseeking

tom

inimise

theirtax

liability,m

aximise

profits,and

avoidonerous

regulatorycontrols.

They

havealso

beeninvoked

byw

ealthyindividuals,

residingin

highlytaxed

orpolitically

unstableenvironm

ents,w

how

ishto

enhancetheir

wealth

legitimately

anddiscreetly.

Indeedstability,

bothpolitical

andfinancial,

andeasy

removal

offunds,

arecharacteristics

which

attractbusiness

toan

offshorecentre,

asthe

absenceof

thesefacilities

might

bethe

veryreason

thatthe

money

isdeposited

offshore.F

orexam

ple,flight

capitaloften

representsm

oneyfleeing

oppressivefiscal

laws

orundem

ocraticregim

es,by

personsstockpiling

theirassets

farfrom

thereach

oftheir

governments.

How

ever,there

isanother

categoryof

userw

hichhas

undermined

theintegrity

ofoffshore

financialinterm

ediation—

thosew

hoexploit

thebenefits

ofthe

offshorew

orldto

promote

theirunscrupulous

activities.In

thisrespect,

theillegitim

atefunds

inoffshore

centreshave

aneclectic

origin,ranging

fromdrug

traffickingand

corruptionto

taxevasion.

Whatever

theirprovenance,

allof

thesefunds

sharea

comm

onbond

ofseeking

sanctuaryin

thefinancial

servicesand

confidentialityoffered

bythe

offshorehavens.

Itis

thisrole

asdepository

ofillegitim

atew

ealth.that

hasled

tothe

lossof

‘paradise’,a

labelcom

monly

associatedw

iththese

tropicalislands.

Fornow

,the

conceptof

offshorefinancial

centreshas

become

synonymous

with

‘money

launderingcentres’.

The

objectiveof

thischapter

isto

explorethe

infrastructureof

theregion’s

offshorefinancial

servicesindustry

(focusingon

thelaw

sof

theB

ahamas

andthe

Caym

anIslands)

andspecifically,

toexam

inethose

aspectsof

theindustry

thathave

beenused

tofacilitate

money

laundering.

DEFIN

ING

THE

Om

sHoan

FIN

AN

c1IN

ousTRY

Afinancial

entitysuch

asa

bankis

designatedas

“offshore”w

herethe

hostcountry

inw

hichit

ischartered

permits

itto

carryon

itsoperations

anywhere

outsidethat

country’sborders.

The

servicesof

suchbusinesses

areconducted

inforeign

currencyand

areprovided

exclusivelyto

non-residentsof

thehost

State.A

countryis

classifiedas

anO

ffshoreF

inancial/Banking

Centre

ifits

bankingbusiness

is“totally

disp

rop

or

tionateto

theneeds

ofthe

domestic

market”

andw

herea

deliberateattem

ptis

made

toattract

offshorefinancial

businessthrough

theim

positionof

minim

altaxation

and

29

Money

Laundering

Control

inthe

Caribbean

acertain

amount

ofbanking

secrecy.tIt

isfor

theform

erreason

thatit

hasbeen

said

thattax

havensare

the“nucleus

ofthe

offshorew

orld”,a

taxhaven

beinga

country

with

azero

orlow

rateof

tax.

2A

partfrom

offshorebanking,

adeveloped

offshore

financialcentre

may

alsoprovide

facilitiesfor

theestablishm

entof

offshorecom

panies

andtrusts.

The

abovedescriptions

ofoffshore

financialinterm

ediationw

ouldcharacterise

severalof

thejurisdictions

examined

inthis

book.C

omm

onwealth

Caribbean

territo

riesassociated

with

thisindustry

includeA

nguilla,A

ntigua&

Barbuda,

theB

ahamas,

Barbados,

Belize,

theB

ritishV

irginIslands,

theC

ayman

Islands,D

ominica,

Grenada,

Montserrat,

Turks

&C

aicosIslands,

St.K

itts&

Nevis,

St.L

uciaand

St.V

incen

t.3

The

conceptof

offshorefinance,

althoughtraditionally

associatedw

ithparticular

geographiclocations,

suchas

theC

aribbeanor

theS

outhP

acific,is

alsoequally

applicableto

largerfinancial

centres,including

London,

which

providefinancial

servicesto

non-residents.In

addition,as

seenin

thepreceding

chapter,w

iththe

dev

el

opment

ofInternet

banksand

banking,the

conventionalnotion

ofoffshore

isassum

ing

newdim

ensions,w

ithoutregard

toterritorial

constraints.

ENrnRG

ENcE

OF

TH

ER

EO

tON

’SO

lwsH

oRE

FtN

AN

ctAL

IND

UST

RY

Inorder

toappreciate

thenature

ofthe

region’soffshore

financialsector

today,a

brief

lookat

itsorigin

isrequired.

The

offshorefinancial

industrybegan

toem

ergein

the

Com

monw

ealthC

aribbeanin

the1960s.

This

was

primarily

dueto

thestringent

restrictionsand

heavytaxation

affectingfinancial

institutionsin

theindustrialised

countries.A

tthe

same

time,

advancesin

telecomm

unicationsand

fundtransfer

mech

a

nisms

permitted

speedierconnections

between

financialentities

aroundthe

world,

while

decreasingthe

expenseof

operatingfrom

distantcen

tres.4

These

factors

prompted

banks,particularly

inN

orthA

merica,

torelocate

some

oftheir

financial

activitiesto

more

liberaljurisdictions

which

affordedthem

fiscaladvantages

through

lowor

notaxes.

Specifically,

thegrow

thof

theoffshore

sectorin

theC

aribbeanm

aybe

attributedto

theim

positionof

capitalcontrols

bythe

US

government

inthe

formof

theInterest

Equalisation

Act

in1963,

theV

oluntaryF

oreignC

reditR

estraintP

rogramand

the

Foreign

Direct

Investment

Program

,both

in1965.

These

measures

were

aimed

at

stabilisingthe

US

balanceof

payments

problem,

byw

ayof

restrainingcapital

outflows.

This

was

inresponse

tothe

increaseddem

andfor

US

currency,outside

of

thatcountry,

byindividuals

andbusinesses

wishing

toinsure

againstdom

estic

currencyinstability

throughsaving

inU

Sdollars.

The

US

financialm

arketbecam

e

segmented,

byrestricting

thenum

berof

loansfrom

localbanks

toforeigners

while

requiringA

mericans

investingabroad

toborrow

abroad.T

hatis,

asystem

ofdom

estic

borrowing

fordom

esticpurposes,

andforeign

borrowing

forforeign

purposes.In

addi

tionto

theabove,

in1966

a‘credit

crunch’w

ascaused

when

theU

Sm

oneym

arket

interestrates

exceededthose

imposed

asa

ceilingon

bankinterest

rateson

US

dollar

dep

osits.

5

M.

Cook,

Offshore

Fina,,cial

Centres

(t98t).

tt.L.

Barber,

nixH

apens,H

owto

Basic

tnvestand

Do

Easiness

—O

f’)horeand

TaxFree

(t993).

Althosgh

notphysically

tocatedis

theC

aribbeas,B

ermsda

isasother

Com

monw

ealthterritory

inthe

Western

Hem

ispherew

hichis

consideredto

beas

offshorefinancial

centre.

M.

Csssard,

“The

Role

ofO

ffshoreC

entresis

tnternationatFinancial

Enterm

ediatios”Ilta’F

Worki,ig

Paper

(1994).Ibid.

30

Offshore

Financial

Havens

andM

oneyL

aundering

In1969

theU

SF

ederalR

eserveB

oardagreed

toperm

itthe

establishment

ofbank

branchesoffshore.

This

was

intendedto

increasethe

effectivenessof

thebanks

by

allowing

themto

avoidregulations

thatm

ightim

pedethem

intheir

bidfor

loansand

deposits,and

was

alsoaim

edat

preventingdepositors

fromm

ovingtheir

money

to

non-bankfinancial

institutionsin

searchof

higherreturns.

The

absenceof

reserve

requirements

anddeposit

insuranceschem

esfor

banksoffshore

renderedit

cheaper

overallfor

themto

obtainfunds,

therebyincreasing

theam

ountof

capitalavailable.

These

conditionsinduced

Am

ericanbanks

toestablish

branchesoffshore

inthe

growing

‘Eurom

arket’5

where

depositscould

bem

adeor

loansbooked

abroadin

US

currency,but

freefrom

therestrictions

imposed

inthe

US.

Ineffect,

thenew

offshorejurisdictions

became

havens,or

sanctuaries,w

herethe

banksand

them

oneyflow

ingthrough

themcould

operateindependent

of,and

unreg

u

latedby,

thelaw

sand

practicesin

theirhom

ejurisdiction.

This

worked

tothe

banks’

own

advantage.T

heem

ergenceof

thesenew

internationalfinancial

centresalso

corre

spondedto

“thenew

articulationof

world

capitaloperating

ona

globalm

arketscale

underthe

hegemony

offinance

capital”and

facilitatedthe

generationof

globalprofit

bytransnational

ban

ks.

7It

isfor

theabove

reasonsthat

them

ajorityof

theoffshore

banksregistered

inthe

Caribbean

areof

US

origin.T

hehistory

ofthese

institutionsalso

explainsw

hyju

ris

dictionssuch

asthe

Baham

asand

theC

ayman

Islandsbecam

eknow

nas

“offshore

bookingcentres”.

That

is,even

thoughthe

financialtransactions

areregistered

there,

some

trsnsactions,particularly

loansor

deposits,are

normally

arrangedand

managed

inanother

jurisd

iction.

8R

egistrationoffshore

was

primarily

forthe

purposeof

taxa

tion,to

benefitfrom

theabsence

ofhigh

taxes.For

banksthis

spellsgreater

profits

sinceneither

theinterest

onloans

bookedthrough

them,

northe

intereston

deposits

made

with

them,

aresubject

tohigh

ratesof

taxation.T

hisenables

thebanks

toborrow

andlend

money

more

competitively

inthe

internationalm

arket.T

heabove

may

bedescribed

asthe

“push”factors

andsince

forevery

actionthere

is

anequal

andopposite

reaction;w

hat,then,

were

the“poll”

factorsinvolved?

That

is,

what

luredthese

entitiesto

theC

aribbeanand

notanother

partof

thew

orld?T

he

strategicposition

ofthe

Caribbean

isone

factor,situated

practicallyin

the‘front

garden’of

theU

S.P

eoplelike

tobe

closeto

theirm

oneyand

theproxim

ityof

the

regionto

theU

Sgave

theA

merican

banksthe

assuranceof

havingtheir

fundsin

placesw

hichare

easilyaccessible.

The

Caribbean

havensalso

hadthe

benefitof

being

inthe

same

time

zoneas

theE

asternseaboard

andfinancial

seatof

theU

S.A

tthis

time

too,the

US

government

was

keento

advocatethe

promotion

ofcapitalism

within

theC

aribbean,in

lightof

Castro’s

successin

implem

entingcom

munism

inC

uba.O

f

course,the

Caribbean

offshoreterritories

were

attractiveto

US

banksprim

arily

becausethey

offereda

combination

ofthe

following:

ano/low

taxregim

e,relief

from

reserveratios,

no-depositinsurance

premium

sand

thesecurity

offinancial

secrecy.

Before

examining

thesecharacteristics,

thestill-unasked

questionof

why

the

Caribbean

was

interestedin

divinginto

“theshark-infested

offshorefinancial

waters”9

must

nowbe

answered.

At

thesam

etim

ethat

theU

Sbanks

were

seekingto

go

‘Eurom

srket’or

‘Eurocarrency

markets’

referto

depositssnd

loansbooked

outsidecountry

inw

hose

carrescythey

aredenom

inated.T

hispractice

originatedin

Europe,

hencethe

term

X.

Gorostisga,

TheR

oleofintern

ationalF

inancialC

e,ttresin

Underdeveloped

Countries

(1984)

tnthe

Baham

asand

theC

aymsn

Islandsthere

areno

taxeson

income

orcspitst

gains.T

hisincludes

the

sbnenceof

directtaxation

onthe

netprofits

sndm

oreim

portantlythe

lackof

anyw

ithltoldiagtases

on

paymesis

arisingfrom

assetsheld

there,Is

bothjurisdictions,

thereare

noestate

orinheritance

taxes

1st.G

illard,“A

ngailiaC

rarksD

own

onF

inancialPiracy”

TheO

bserver,M

ay27,

t990

31

Money

IjiunderingC

ontrolin

theC

aribbeanO

ffshoreF

inancialH

avensand

Money

Laundering

offshore,several

territoriesof

theC

omm

onwealth

Caribbean

were

emerging

intothe

eraof

politicalautonom

y.’0

The

achievement

ofeconom

icindependence

fromthe

UK

was

thusof

paramount

importance.

Em

barkinginto

theoffshore

world

gavesom

eof

thesecountries

thechance

todiversify

theireconom

yfrom

apurely

tourism-dependent

one.T

heycould

nowestablish

themselves

asa

seriousfinancial

centre,w

hileshaking

offtheir

carefreeim

ageof

simply

beingplaces

of‘sand,

seaand

funin

thesun’.

Sow

henthe

Am

ericanbanks

came

knocking,m

anyterritories

foresawa

goldeneconom

icopportunity

andflung

theirfinancial

doorsopen

toem

bracethese

intermediaries,

onearm

bearingm

inimal

taxationand

theother

financialsecrecy.

Indeed,the

regioncontinued

toplay

therole

ashost

totourists,

butfrom

thistim

eonw

ardstheir

guestlist

includednot

onlytravelling

peoplebut

alsom

oneyon

them

ove.B

ythe

early1980s,

theU

SF

ederalR

eserveallow

edA

merican

banksto

establishInternational

Banking

Facilities

(lBF)

athom

e.T

hisenabled

themto

dealw

ithforeign

customers

freeof

reserverequirem

ents,interest

rateceilings

anddeposit

insurance,w

ithoutresort

toan

offshorefacility.’1

Thus,

thevery

factorsw

hichforced

severalbanks

offshorew

ereno

longeran

obstacle.O

ffshorecentres

beganto

losesom

eof

theirappeal

andby

1982nearly

400banks

hadestablished

IBFs

andshifted

theirassets

andliabilities

home

fromexisting

entitiesin

theC

aribb

ean)

2T

oday,as

thefro

ntiers

between

onshoreand

offshoreactivity

become

blurredby

financialliberalisation

andderegulation,

ithas

beensuggested

thatthe

needfor

theoffshore

financialsector

will

diminish.’3

Nevertheless,

asthe

infrastructurefor

offshorefinance

hasalready

beenput

inplace,

thew

iderange

ofservices

availablecontinues

toentice

bothleg

itim

ateand

illegitimate

users.O

neof

thecore

featuresof

offshorecentres

isthe

absenceof

hightaxation.

This

has

always

beenparticularly

attractivefor

thoseresident

tnhigh

taxjurisdictions,

asit

isperfectly

legitimate

fora

taxpayerto

decreasethe

amount

ofw

hatw

ouldotherw

isebe

histaxes,

oraltogether

avoidthem

,by

means

which

thelaw

perm

its.’4

Indeed,tax

havensby

definitioncapitalise

ona

taxpayer’sdesire

tom

inimise

liabilityto

taxat

home.

Am

uch-publicisedexam

pleof

sucha

planw

asthe

taxavoidance

effortsof

Geoffrey

Robinson,

former

UK

Paym

aster-General.’

5T

hissituation

highlightedthe

useof

offshoretrusts

inth

etax

havensof

Berm

udaand

Guernsey

toreduce

liabilityfor

taxin

theU

K.

Whilst

thetransactions

may

havecalled

intoplay

moral

andethical

issues,they

didnot

crossthe

nebulousline

intothe

sphereof

unlawful

taxevasion.

Incases

suchas

this,the

useof

offshorejurisdictions

isfrow

nedupon

becauseit

facilitates

thediversion

ofcapital

generatedin

anotherjurisdiction.

How

ever,as

longas

draconianlevels

oftaxation

andexchange

controlspersist

inother

jurisdictions,the

offshoreindustry

will

continueto

flourish,by

drivingoffshore

thosefunds

thatw

ouldotherw

isebe

on

sho

re.’6

The

dangerarises

where

thetransactions

involvedhave

thedesign

andeffect

ofconcealing

thevery

existenceof

thefunds

fromthe

relevantauthorities.

The

resultis

0T

hisw

asespecially

truefor

theB

ahamas

which

gainedits

politicalindependence

in1973.

The

Caym

anIslands

bysum

time

hadbees

grantedself.governing

statusalthough

itrem

aineda

dependentterntary

of

theU

nitedK

ingdom.

1U

SD

epartment

ofT

reasury,Tax

Havens

inthe

Caribbean

(1985).M

anybanks

stiltretained

ashett

entityoffshore.

Cassard

opcit.

Gregory

itH

eis’ering293 u.s.

465(1935).

5D

Leppard

and3.

Burke,

“Robinson’s

Berm

udaTax

Haven”

SundayTim

es.D

ecember

7,1997.

10L

ambert,

“IviarketingT

rustServices

inthe

90’s”puper

presenteda,

theC

uyman

Islands5th

Oie,iniel

Conference,

Jannaryt997.

acoincidence

oftax

evasionand

money

laundering,and

may

arisew

herethe

wealth

isplaced

ina

secretoffshore

bankaccount,

orin

thenam

eof

anoffshore

company,

andnot

declaredto

therevenue

authorities.Indeed,

inthe

1980s,a

US

Senate

investigationconsrnittee

foundthat

therew

erea

largenum

berof

transactionsinvolving

legallyand

illegallyearned

income,

which

was

divertedto

orpassed

throughhavens

forthe

purposeof

taxev

asion.’

7T

heestablishm

entof

offshorefinancial

centresin

theC

aribbeanw

asa

responseto

soundfinancial

needs,but

thedem

andfor

theirservices

remained

elasticto

changesin

theirtaxes

andregulations.

As

theoffshore

world

became

more

crowded,

competition

increasedand

Caribbean

offshorecentres

were

forcedto

offerhighly

attractiveleg

islation

foroffshore

activities,often

without

installingthe

necessaryuafeguards.

Inretrospect,

onecould

saythat

thefollow

ingstatem

entcaptures

theunofficial

butunderlying

approachtaken

bym

anyC

aribbeancentres

indeveloping

theiroffshore

industry:

[T]he

Baham

asm

ustdo

thingsw

hichare

notallow

edin

theU

Sbecause

todo

thingsw

hichare

allowed

inthe

US

isnon-com

petitivesince

inevery

instancethe

US

doesit

betterthan

theB

ahamas

do.T

heB

ahamas

aretherefore

compelled

inbanking

andtrust

operationsto

appealto

unallowable

activitiesand

byinference

toappeal

toactivities

disallowed

inthe

US.us

This

statement

isequally

applicableto

theattitude

ofsom

eof

theother

Caribbean

offshorecentres

when

enticingthe

offshorem

arketto

theirshores.

Indeed,it

was

theeagem

eusof

theregion

tofind

aniche

inthe

offshorew

orldthat

ledit

toventure

hastilyinto

theuncharted

waters

ofthe

offshorew

orld.In

many

cases,the

supportinginfrastructure

would

notbe

inplace,

furtherexposing

thejurisdiction

tothe

dangersof

offnhorefinancial

intermediation.

Forinstance,

untilthe

rnid-1960sthere

was

nospecific

legislationgoverning

theoffshore

financialsector

inthe

Baham

asand

theC

ayman

Islands.O

necould

simply

setup

acom

panyand

giveit

fullbanking

powers

and,w

ithoutm

ore,have

anoffshore

bank)

9B

yw

ayof

contrast,B

arbadoscam

eon

boardthe

offshorefinancial

scenelater

inthe

day,and

havinglearned

fromthe

bittersweet

lessonsof

theirneighbours,

tooka

more

cautiousapproach.

Itw

asindeed

theobjective

ofthe

architectsof

thatcountry’s

offshoreindustry

toprom

otethe

islandas

a“responsible

offshorefinancial

centre”.2°

Thus,

in1977

when

theB

arbadiangovernm

entdeclared

itsintention

todevelop

theisland

asa

taxhaven

andoffshore

financialcentre,

thethen

Attorney-G

eneraladam

antlyexpressed

thegovernm

ent’srefusal

tocreate

conditionsthat

would

facilitatethe

launderingof

illegalfunds

andem

phasisedits

determination

“toexercise

theutm

ostvigilance

soas

toexclude

dishonestand

criminal

transactionsw

hichcould

impugn

Barbados’

reputatio

n”.

2t

By

thistim

etoo,

theU

Khad

begunto

takea

keeninterest

inthe

Caribbean

offshorefinancial

centresand

assistedthe

Barbados

government

US

Departm

entuf

Treasury,

TaxH

avensin

theC

aribbean(1985).

An

unnamed

Baham

isnexecutive

quotedin

R.

Btum

,O

ffshoreB

unks,T

rustsand

Com

panies—

TheB

usinessof

Crim

ein

theE

uromarket

(1984).T

heB

unkand

Trust

Com

panyR

egutatiousA

ctt965

(Baham

as)and

theB

ankand

Trust

Com

panyR

ngnlationnL

awt966

(Caym

an)sought

toim

poseu

licensingprocedure

forthe

formation

ofnew

banksand

trustcom

paniesin

therespective

jurisdictions.3

()()O

ffshoreB

unkingA

ct(1979).

SiQ

uotedin

B.

Rider,

“Burbados

Governm

entto

Devetop

Istandus

aT

axH

aven”(1981)

2C

ompany

Law

yer42.

3233

Money

Laundering

controlin

theC

aribbeanO

ffshoreF

inancialH

avensand

Money

Laundering

inensuring

thatits

offshoreindustry

was

properlym

onitored,including

aidingin

thecreation

andstaffing

ofthe

postof

Inspectorfor

Securities.

This

conservative

approachto

offshorefinance

hasenabled

Barbados

torem

aina

relativelyclean

centre

,22

while

stillbecom

inga

“genuine,unique

‘one-stopshopping’

offshorebusiness

centre”.

23

THE

FAC

ILIT

AT

OR

SO

FM

ON

EY

LA

uN

oE

ruIo

Any

kindof

internationalcrim

inalw

hosegoals

areto

continueoperations,

increase

profitand

avoiddetection

will

runa

criticalphase

ofhis

businessthrough

theoffshore

havenbank,

trustand

company

syste

m.

24

As

will

beshow

n,it

isbecause

oftheir

easy

formation,

minim

alcontrols

andconfidentiality

thatthe

offshorebank,

company

and

trusthave

them

ostappeal

topotential

money

launderers.E

achof

thesefinancial

veh

i

clesand

thesecrecy

attachedto

themw

illnow

beexam

inedin

greaterdetail.

Offshore

Banks

SeveralC

omm

onwealth

Caribbean

jurisdictionsrem

ainvibrant

offshorebanking

centres,com

prisingboth

fullservice

branchesof

intemational

banksw

hichoffer

offshorebanking

facilities,as

well

aslim

itedservice

offshorebanks

thatcater

exclu

sivelyto

non-residents.T

helatler

may

berestricted

tospecified

customers

oru

nre

strictedto

anynon-residents.

Abank

isdesignated

as“offshore”

where

itis

charteredor

licensedto

operalew

ith

customers

outsidethe

bordersof

thehost

country.S

inceit

isnot

allowed

todo

bu

si

nessw

ithlocal

residentsall

itsfunds

must

besolicited

fromthose

residentoutside

that

countryor

fromanother

offshoreen

tity.

25

As

describedabove,

many

Caribbean

offshorecentres

areessentially

“financial

entrepots”or

bookingcentres.

Thus,

inm

ostcases,

theoffshore

banksact

asa

mere

conduit,w

herebynon-resident

foreigncurrency

fundsare

depositedinto

andthen

channelledthrough

theseinterm

ediariesto

othernon-resident

borrowers.

Often,

these

transactionsare

merely

enteredin

thebank’s

recordsbut

nophysical

movem

entof

fundsis

involved.A

ssuch,

them

ajorityof

theseoffshore

banksdo

notoccupy

abuilding

oftheir

own,

nordo

theyhave

vaultsor

employ

localstaff

toservice

their

operations.S

incethey

neverhandle

cashbut

merely

recorddeposits

andloans,

nothing

more

thanpaperw

orkchanges

hands.T

heyare

essentially“shell”

banks,their

physical

presenceon

theislands

limited

toa

name-bearing

brassplate

andtheir

representative

alocal

lawyer

orother

residentagent.

This

deficiencyof

realentities

andthe

multitude

ofpaper

onesw

hosestock-in-trade

is“fictitious”

orunseen

capital,have

beensaid

to

addan

airof

illusionand

make-believe

tothese

offshorecen

tres.

26

Barbados

isclassified

asa

Jurisdictionof

Concern

bythe

US

Departm

entof

State,

lnserssatiosnl

Narcotics

ControlS

trategyR

eport2001

(2002).It

isnot

considered,by

theFA

TF,to

bea

uos-cooperattve

jurisdictionin

thefight

againstm

oneysundering

(seeC

hapter10).

Ernst

&Y

oung,B

arbados:a

Unique

Offshore

Business

Centre

(1990)B

arbadosoffers

offshorebank,

trustand

insuranceservices

asw

ellas

offshoretrading

companies.

R.

Bistro

op.cit.

These

may

includeoffshore

companies.

Forexam

ple,a.

6(6)(a)B

anksand

Trust

Com

paniesL

aw(2001

Rev.)

(CI.).

26S

M.

Roberts,

TheL

ocaland

tileG

lobal:T

heC

aynsanIslands

a,sdthe

lvternotiosialFissancial

Systesn,

unpublishedPhD

thesisS

yracuseU

niversity(1992).

Nevertheless,

theseshell

banksare

entitledto

maintain

acorrespondent

relationship

with

aforeign

bank.T

hisw

ouldusually

involvethe

offshorebank

aligningitself

with

am

ajorbank

which

isa

mem

berof

oneof

theinternational

electronicclearing

systems,

suchas

CH

JPSor

SW

IFT

.27

The

correspondentbank

isthen

ableto

provide

essentialm

oneytransm

issionservices

forthe

shellbank,

includingw

iretransfers.

AU

SS

enatereport

foundthat

largebanks

inthe

US

manage

thousandsof

correspon

dentrelationships

with

banksat

home

andab

road.

28

Som

eof

thesecorrespondent

banksprocess

asm

uchas

US$1

trillionin

wire

transfersd

aily

.29

Fora

laundererw

ith

anoffshore

bank,the

abilityto

havea

correspondent bankingrelationship

would

there

forenot

onlyprovide

hisbank

with

apatina

ofrespectability,

itw

ouldalso

facilitate

thepassage

offunds

aroundthe

world.

How

ever,not

alloffshore

banksare

shells,as

thereexist

branchesof

major

foreign

banksw

hichm

aintaina

physicalpresence

inthe

region.In

additionto

providingfu

ll

servicebanking

todom

esticcustom

ers,they

haveInternational

Private

Banking

facilitiesw

hichallow

themto

conductoffshore

businessw

ithnon-residents.

The

development

ofthis

practicew

asintended

toallow

thebanks

totap

theresources

of

highnet

worth

foreigners.T

heoriginal

ideaw

asthat

theinvestm

entneeds

ofaffluent

foreignerscould

besatisfied

byselling

thempersonalised

bankingand

trustproducts,

asw

ellas

advisoryservices.A

lthoughaim

edat

individualsw

ithvast

sums

ofinherited

wealth

andnew

highearners

suchas

entertainers,this

servicehas

aluocaptured

the

fundsof

richcrim

inalsseeking

tolaunder

criminal

money,

orthoae

wishing

tosecrete

privatew

ealthfrom

theirhom

egovernm

ents,in

theform

offlight

capita

l.3°

Now

adays,anyone

wishing

toconduct

thebusiness

ofoffshore

bankingis

required

toobtain

abanking

licence.T

hisis

usuallygranted

onapplication

supporledby

the

requisiteinform

ationand

particu

lars.3’

Aprospective

licenseem

ustdesignate

alocal

addressas

itsplace

ofbusiness

andnam

eits

residentagents.

32

Alicence

will

usually

begranted,

oncethe

carryingon

ofsuch

bankingbusiness

isnot

deemed

tobe

against

thepublic

interesL33

Opportunities

form

oneylaunderers

couldarise

where

thelicensing

proceduredoes

notinvolve

therigorous

screeningof

theprospective

licensee,such

as

obtainingdata

onthe

applicant’sfinancial

statusand

history,the

characterand

exp

eri

enceof

thedirectors,

detailsof

non-residentshareholders,

andcapital

adequacy.

Ow

ninga

bankw

ouldbe

evensim

plerw

herethere

isno

requirement

foroffshore

banks

controlledby

non-residentsto

havean

authorisedcapital

thathas

beensubscribed

and

paidup.

Indeed,the

relativesim

plicityw

ithw

hichoffshore

bankinglicences

couldbe

obtained,in

some

offshorejurisdictiono,

ledto

thedevelopm

entof

anindustry

of

brokeringor

retailingoffshore

banksin

the1980s.

34

By

this,an

entrepreneurial

investorw

ouldacquire

anum

berof

bankinglicences

andresell

themto

otherforeigners,

asC

learingH

ouselaterbank

Payment

System(C

HIPS)

andthe

Societyfor

Worldw

ideInserhauk

Financial

Telecom

munications

(SWIFT

)(see

alsodiscussion

inC

hapter7

relatingto

theuse

ofw

iretranslers

for

mosey

laundering).U

SSenate,

Minority

Staffof

theP

en-sanestSub-C

omm

itteeon

Investigations.R

eporton

Correspondent

Bankissg:

AG

atess’ayfo

rM

oneyL

aundering,F

ebruary5,2001.

26Ibid.

°S

M.

Roberts

op.cit.

asFor

example,

Banks

andT

rustC

ompanies

Law

(2001R

ev.)(“B

TC

L”)

(Cl.);

Bank

andT

russC

ompanies

Regulation

Act

2000(“B

TC

A”)

(Bah).

s.4

BT

CA

(Bah.);

s.6

BT

CL

(CI.).

a.6

BT

CL

(C.!.);

s.4

BT

CA

(Bah.).

asSom

eof

them

ostnotorious

ofthese

estrepreneursw

erein

thebusiness

ofpurchasing,

marketing

and

resellingoffshore

bankinglicences.

mostly

tofraudsters.

3435

Money

Laundering

Control

inthe

Caribbean

Offshore

Financial

Havens

andM

oneyL

aundering

oftento

thoseseeking

adevice

forlaundering

wealth

orfor

defraudingunsuspecting

investors.C

onsequently,the

offshorefinancial

centresof

theregion

gainednotoriety

as

a“spaw

ningground

forsm

all,shadow

yprivate

banksw

hosem

ainactivity”

was

‘turningout

phoneyfinancial

documents

thatare

used..(for)

illegalp

urp

oses”.

35

Suchpractices

prompted

theB

ritishgovernm

entto

intervenein

thefinancial

affairs

ofM

on

tserrat3

tin

1991,and

pressureits

cabinetinto

revokingthe

licencesof

nearly

200offshore

banksw

hichw

ereallegedly

engagedin

unlawful

activities.

37

Inthat

yeartoo,

theshady

dealsand

operationsof

theO

wens

Bank

andT

rust

Com

panyin

St.V

incentw

ereexposed.

This

followed

theconviction

ofthe

bank’s

chairman

andm

anager,by

anItalian

court,in

connectionw

itha

£150m

illionin

terna

tionalfraud

andm

oneylaundering

schem

e.38

The

bankhad

beenunder

observationby

theC

omm

onwealth

Secretariat

andthe

UK

government,

sincethe

mid-1980s,

during

which

time

aB

ankof

England

reportexpressed

concernthat

theSt.

Vincent

bankw

as

engagingin

illicitactiv

ity.

39

Am

orerecent

example

ofthe

abuseof

offshorebanks

isthat

ofA

ntiguaand

the

infamous

European

Union

Bank.

The

misleadingly

titledand

self-proclaimed

“world’s

firstInternet

bank”

4°w

asallegedly

afront

forthe

Russian

mafia,

Setup

forthe

purposesof

launderingtheir

money

andcom

mitting

fraud,(including

misappropri

stingits

depositors’m

oney

).4t

When

theA

ntiguanauthorities

revokedthe

bank’s

licencein

1997,they

alsoshut

down

fiveother

Russian-O

wned

offshorebanks

whose

operationsw

ereequally

suspect.

To

date,the

most

spectacularabuse

ofthe

offshorebanking

sectoris

thatof

the

internationalfinancial

conglomerate,

theB

ankof

Credit

andC

omm

erceInternational.

The

bankw

asregistered

inC

ayman

asthe

principalbanking

subsidiaryof

BC

CI

Holdings

SA,

which

was

establishedin

Luxem

bourgas

aholding

company

and,

consequently,not

regulatedas

abank

inthat jurisdiction.

This

structureenabled

BC

CI

tobe

“offshoreeveryw

here”thereby

avoidingany

centralregulator

orcom

prehensive

supervisionof

itso

peratio

ns.

42

At

thetim

eof

itsdem

ise,the

BC

CI

(which

had

branchesin

overseventy

countries)w

asfound

tobe

involvedin

illicitactivities

on

aw

orldwide

scaleranging

frombanking

fraudto

drugm

oneylaundering.

This

was

possiblebecause

nosingle

regulatorknew

what

thebank

was

doingbeyond

its

jurisdiction.A

nothersim

ilarlystructured

institutionw

asthe

Caym

anxbank

which

operatedin

theIsle

ofM

anas

asubsidiary

ofan

institutionin

theC

ayrnanIslan

ds.

43

Since

itw

as

effectivelyoffshore

toboth

jurisdictions,it

operatedfree

ofregulation.

Indeedit

boastedon

theIntem

etthat

itsclients’

recordsw

erefree

fromoversight

bythe

authorities

ofany

jurisdiction.

°S

Drinkall,

“Con

Meo

areR

akingin

Miilions

byS

ettingU

pO

wn

Caribbean

Banks”

tOut

Street

Journal,M

arch23,

1981.ss

One

ofits

dependentterritories.

“B

Rider,

“The

Cost

ofL

aundry”(1995)

16C

ompany

Louvyer

34.T

hisaction

alsoresatted

inthe

arrest

of2

Ministers

forcorruption.

Si

,Stailon

Sunday.“Storm

hitsoffshore

bank,”A

ugnst4,

199i.

Ibid.T

hebank’s

servicesw

ereconducted

viathe

Internet.4t

The

casealso

highlightsthe

potentialfor

abuseof

bankingover

theInternet

where

totalanonym

itycan

beachieved

andalso

theabsence

ofcontrols

onthe

Internet.42

J. Adam

sand

D.

Frantz,A

Full

ServiceB

ank—

How

BC

CI

StoleB

illionsA

roundthe

World

(1992).

Referred

toin

US

Departm

entof

Stote,International

Narcotics

Control

StrategyR

eport1998

(1999).

Offshore

Com

panies

With

thehelp

ofa

locallaw

yerand

forthe

appropriatelicensing

fee,a

wealthy

foreignercan

hidehis

identitybehind

anew

lycreated

butfictitious

corporation,the

activitiesof

which

would

becouched

invague

andobscure

terms

beneaththe

veneerof

ageneric

corporatenam

e.

44

The

launderer’snam

eneed

notappear

onthe

registra

tionpapers

asnom

inees,including

theincorporating

lawyer,

may

beused

toprovide

himw

ithan

additionallayer

ofprotection.

These

offshorecom

paniesare

recognisedlegal

personsand,

apartfrom

aprohibition

againstpurchasing

realproperty

inthe

offshorejurisdiction,

theym

ayacquire

assetsand

operatebank

accounts.C

omm

onm

oneylaundering

schemes

would

involvethe

useof

offshorebank

accountsheld

inthe

names

ofshell

companies,

andthe

transferof

suchfunds

toa

bankaccount

heldby

anoffahore

company

inanother

offshoreju

risdiction,

The

FAT

Fhas

reiteratedthat

shellcorporations

continueto

figuresignificantly

inm

oneylaundering

activitiesand,

indeed,rem

ainone

ofthe

primary

toolsem

ployedby

professionalm

oneylaunderers.

They

notethat

sincethere

hasbeen

arise

inthe

useof

bankaccounts

inthe

names

ofshell

companies

toshelter

profits,countries

shouldtake

noticeof

thepotential

forabuse

ofshell

corporationsby

money

launderersand

shouldconsider

whether

additionalm

easuresare

requiredto

preventunlaw

fuluse

ofthese

entities,

45

Inm

anyC

aribbeanjurisdictions

thereare

facilitiesfor

theform

ationof

offshorecom

panies.T

heseare

essentiallycom

paniesthat

areset

upto

dobusiness

exclusivelyw

ithpersons

residentoutside

thejurisdiction,

They

areusually

precludedfrom

carryingon

banking,trust

orinsurance

businessand

areintended

toengage

inforeign

trade.In

some

jurisdictionsthere

existsthe

creatureknow

nas

theInternational

Business

Com

pany(IB

C),

The

IBC

may

beprohibited

fromow

ningan

interestin

realproperty

locally,save

fora

leaseof

anoffice.

Itis

usuallycharacterised

byits

easeof

incorporation,

exemption

fromtaxation

andconfidentiality

forits

mem

bers.For

instance,in

theB

ahamas

thereused

tobe

a24-hour

servicefor

incorporationof

anew

entity,w

ith“off-the-shelf”

com

pan

ies4

6available

forpurchase.

This

processallow

edfor

theform

ationof

acom

panyw

ithoutthe

owners

everhaving

toappear

inperson.

Moreover,

oncethe

Mem

orandumof

Incorporationand

othersupporting

documents

were

submitted

theyw

ereinspected

andapproved

within

oneday

ofbeing

lodged.T

hisfast

trackservice,

popularlyknow

nas

“theinstant

registrationpackage”,

was

manifestly

inadequatefor

aproper

verificationof

thebona

fidesof

theow

nersand,

consequently,w

assubject

toabuse

.47

The

parallelin

theC

ayman

Islandsis

theexem

ptedcom

panyw

hoseoperations

must

takeplace

mainly

outsidethe

jurindiction,O

therpotentially

appealingfeatures

arethat

itm

aybe

registeredas

acom

panyof

limited

durationand

soautom

aticallycease

toexist

ona

dateless

than30

yearsfrom

thedate

ofincorporation

oron

thehappening

ofa

specifiedevent.

48

Capital

may

bedivided

intoshares

without

nominal

orpar

valu

e49

andthere

arealso

nom

inimum

capitalrequirem

entsfor

suchcom

panies.

R.

Ehrenfeld,

Evil

Money

—E

ncountersA

longthe

Money

Trail

(1992).a

FAT

FR

ecomm

endation25

(t996).46

These

arepre-incorporaled

companies.

tBC

sare

nowgoverned

bythe

InternationalB

nninensC

ompanies

Act

2000(“IB

CA

ct”)w

hichcontains

some

stricterprovisions

thanits

predecessor.us.

197to

201C

ompanies

Law

(2001).A

tthis

time

theexem

ptcom

panyw

illbe

takento

basev

olu

ntarily

wound-np

anda

liquidatorappointed.

s.8

(i)C

omponies

Law

.

3637

Offshore

Financial

Havens

andM

onrryL

aundering

Money

Laundering

Control

inthe

Caribbean

Insom

ejurisdictions,

bearershares

areperm

ittedfor

companies

conductingsolely

offshorebusiness,

sothe

identityof

thebeneficial

owner

may

notbe

ascertainable.

Bearer

sharesenable

ownership

tobe

vestedin

theperson

who

isin

possessionof

the

sharecertificate.

The

name

ofthe

shareholderis

noton

thecertificate

noris

aregister

ofthe

names

ofsuch

shareholderspossible,

sincetransfer

ofow

nershipis

effected

merely

ondelivery

ofthe

sharecertificate.

This

devicehas

thereforeafforded

the

shareholderscom

pleteanonym

ity,as

thetrail

ofow

nershipw

ouldbe

impossible

to

establish.In

a1990

reportto

theH

ouseof

Co

mm

on

s,5°

thepotential

dangerof

bearer

sharesw

asacknow

ledgedand,

becausethey

allowtotal

anonymity

forow

ners,ii

was

recomm

endedthat

theiruse

inthe

Caym

anIslands

andother

UK

Dependent

Territories

shouldbe

abo

lished

.5’

Itm

ayalso

bepossible

touse

nominee

shareholdersto

shieldthe

trueidentity

ofthe

beneficialow

nersof

theshares.

By

this,a

laundererw

ouldnom

inateanother

person,

suchas

anoffshore

lawyer,

bankor

trustcom

panyto

holdhis

sharesin

thatnom

inee’s

name.

This

addsa

furtherlayer

ofprivacy,

sincein

additionto

thelaunderer

notbeing

named

onthe

officialcom

panydocum

ents,the

nominee

would

alsobe

boundby

con

fi

dentialityobligations

notto

disclosethe

identityof

thebeneficial

owner.

Inreality,

them

ajorityof

offshorecom

paniesare

mere

shells,w

ithno

realfu

nc

tions.T

heyexist

asfigureheads

ofthe

owners

and,for

money

launderers,act

as

aperfect

funnelthrough

which

topass

illicitw

ealth.T

helaw

reportsare

replete

with

examples

ofshell

companies

beingused

asinstrum

entsfor

wrongdoing.

For

instance,in

Agip

(Africa)

Ltd.

v.Jack

son

,52

money

defraudedfrom

theplaintiffs

was

paidinto

theaccounts

ofseveral

papercom

paniesw

hichw

ereset

upfor

thesole

purposeof

actingas

recipientsfor

theproceeds

offraud.

Ineach

casethe

company

had

anom

inalshare

capital,no

assets,and

carriedon

nobusiness

activity,and

was

infact

putinto

liquidationby

theow

neras

soonas

itfulfilled

itsrole

asrecipient

ofthe

payments.

Similarly,

ina

BC

CI-related

case,the

accusedw

ascharged

with

falseaccounting

andconspiracy

todefraud,

where

heerected

acom

plexstructure

ofoffshore

com

pa

niesto

mislead

theB

CC

I’sauditors

intofalsely

believingthat

realbusiness

was

being

conductedw

ithunconnected

com

pan

ies.55

Infact

thecom

paniesw

erem

ereshells

and

theirtransactions

wholly

fictitious.

54

As

illustrated,m

anyof

theseoffshore

companies

arem

erenom

inees,nothing

more

thana

name

ona

bankaccount,

usedpurely

asvehicles

forthe

transferof

money

.55

Above

all,it

isthe

easeof

incorporation,the

lackof

supervisionover

theiractivities

andsecrecy

surroundingthe

operationof

theseoffshore

companies

thatrender

them

aperfect

money

launderingvehicle.

50R

odneyG

allagher,C

oopers&

Lybrand

Report

onthe

Surveyof

Offshore

Financial

Sectors

inthe

Caribbean

Dependent

TerritorieS

(1990).

a.185

Com

paniesL

aw(C

l.)perm

itsbearer

sharesas

longas

company

doessot

holdland.

Inthin

Juris

diction.in

orderW

imm

obilinebearer

sharesand

limit

theirpotential

forabuse,

thebearer

sharesm

ust

beissued

toan

authorisedcustodian,

suchas

abank

ortrust

company.

The

latteris

requiredto

keepa

recordof

theshares,

includingthe

identityof

thecom

panyissuing

theshares

(s.I 87

Com

paniesL

aw).

Rearer

shareshave

beenabolished

inthe

Baham

asunder

s.10(a)

IBC

Act

(2000).

52[1990]

Ch.

265.R

toG

okal(1997)

2C

r.A

pp.R

.266.

Ibid.p

erM

illettI.

Agip

s.Jackson

op.cit.

Offshore

Insurance

Many

ofthe

offshoreC

aribbeanhavens

havean

activecaptive

insuranceindustry,

that

inan

insurancebusiness

whereby

allrisks

andprem

iumu

originateoutside

theju

risdic

tion,and

where

thatcom

panyis

owned

mostly

byn

on

-residen

ts.56

Inm

anycases,

the

captivecom

panyis

aw

hollyow

nedsubsidiary

ofa

foreigncom

panyand

thestru

c

tureis

invokedas

atax

avoidanceschem

e.T

hus,in

theonshore

countrythe

parentcom

panyin

ableto

deductthe

payment

ofthe

premium

s,and

sincethe

insu

r

ancecom

panyis

ina

taxhaven,

thereceipt

ofthe

premium

sdoes

notattract

anytaxeo

offsh

ore.

57

There

issparse

dataon

theuse

ofoffshore

insurancecom

paniesfor

thepurpose

of

money

launderingbut,

giventhe

easeof

formation

ofthese

entitiesand

associated

secrecy,

58

thereis

noreason

why

theycould

notbe

usedas

anotherm

oneylaundering

vehicle.Indeed,

theFA

TF

hasidentified

thegrow

inguse

ofthe

insurancesector

for

money

laun

derin

g.

59

This

usuallyoccurs

throughthe

purchaseof

insuranceproducts,

redeeming

themfor

a‘clean’

chequefrom

theinsurance

com

pan

y.

6°

An

example

ofthe

abuseof

theoffshore

sectorinvolving

theinsurance

industryw

as

revealedduring

aninvestigation

intothe

allegeduse

ofre-insurance

companies

regis

teredin

theC

aribbeanby

theA

merican

mafia.

This

formed

partof

ahuge

fraudand

money

launderingsc

am

.6t

Apparently

thecom

paniesw

erebogus,

inthat

theyhad

no

realassets,

buttheir

balancesheets

were

bolsteredthrough

asset-rental,and

borrowing

propertyfrom

legitimate

firms.

The

scheme

involvedcustom

ersbeing

trickedinto

payingcut-price

premium

sto

thecom

panies,but

oncea

largeclaim

was

made

the

offshoreinsurance

company

would

beput

intoliquidation,

andthe

criminals

would

escapew

iththe

money,

which

hadalready

beensiphoned

tooffshore

bankacco

unts.

62

Offshore

Trusts

Another

devicethat

may

beused

forlaundering

wealth

inthese

havensis

theoffshore

trusL

Inthe

typicalsituation,

theoffshore

trustis

usedfor

placingthe

ownership

of

assetslocated

abroadin

thehands

ofindividuals

orcorporations

basedin

thehaven

country

.63

The

latterw

ouldhold

theassets

ontrust

forthe

benefitof

beneficiaries

residingelsew

here,To

addanother

strandto

thelaundering

web,

offshorecom

panies

may

beused

asthe

settloror

beneficiaryof

theoffshore

trust.For

instance,the

Caym

anianlaw

allows

anexem

ptcom

panyto

beregarded

asnon-resident

inthe

Caym

anIslands,

forthe

purposeof

beinga

beneficiaryof

anoffshore

trust.

64

Atrust

involvesthe

separationof

thelegal

andbeneficial

ownership

ofproperty

between

thetrustee,

inw

homlegal

titleresides,

andthe

beneficiariesw

hopossess

56See

forexam

ple.R

xempt

InsuranceA

rt(1983)

(Bah.).

ntn

some

jurisdictions,off-the-shelf

entitiesare

available.

Insom

ejurisdictions,

thereisa

requirement

tofile

financialstatem

entsbut

theseare

natopen

topublic

scrutinyand

thereis

nopublic

recordof

thecom

pany’sshareholders.

nFA

TF,R

eporton

Money

Laandering

l)pologies(1996).

Crim

inalsoperating

onshorecould

arrangeto

havean

insurancecom

panyset

upin

anoffshore

jurisd

ic

tion.It

would

then‘sell’

theman

insurancepolicy,

andafter

payinga

lump

samprem

ium,

thepolicy

couldbe

terminated

andthe

moneys

returned.

M.

Sheehanand

13.L

eppard,‘P

oliceP

robe£100m

City

Sw

indle”The

limes,

March

14,1999.

The

scheme

alsoallegedly

involvedthe

infiltrationof

theL

loyd’sinsurance

market.

62Ibid.M

.G

rundy,Tax

Havens-O

ffshoreB

ankingC

enters:A

World

Survey(1993).

ss.74(1)

ned86(1)

Trusts

Law

(2001R

ev.).

38

39

Money

Laundering

Control

inthe

Caribbean

Offshore

Financial

Havens

andM

oneyL

aundering

anequitable

interestin

thetrust

property.It

may

becreated

bythe

settlordeclaring

himself

astrustee

ofthe

propertyfor

thebenefit

ofanother

orit

may

arisew

herethe

seniorm

akesan

intervivos

ortestam

entarytransfer

ofproperty

tothe

trusteefor

the

benefitof

otherpersons

(orfor

theadvancem

entof

certainpurposes).

The

classicfu

nc

tionof

anoffshore

trusthas

beento

make

financialprovision

forrelatives

confronted

byvolatile

events,including

war

orsom

eform

ofpersecution.

Ithas

alsobeen

invoked

bym

ultinationaltrading

companies

concernedabout

therisk

ofexpropriation

of

corporateassets

locatedin

politicallyunstable

jurisdictions.

Ithas

beensuggested

thatthe

recentgrow

thin

offshoretrusts

canbe

attributedto

theexplosion

ofthe

litigationindustry

inthe

US,

asthis

representsan

increasedthreat

toindividual

andcorporate

wealth

fromthe

fullrange

ofcontract

andtort

law

.65

Inthis

regard,there

isan

addedperception

thatthe

courtsare

more

plaintiff-orientedand

willing

togrant

unlimited

damage

awards.

As

such,those

fearinglitigation

against

themhave

soughtto

protecttheir

wealth

byusing

offshoretrusts.

How

ever,in

addition

tothese

motivating

factors,the

offshoretrust

hasbeen

usedadvantageously

bythose

wishing

tosecrete

wealth

forother

lesshonourable

purposes.

Since

thebeneficial

ownership

intrust

propertypasses

tothe

beneficiaries,it

falls

outsidethe

ambit

ofthe

settlor’sor

trustee’sassets

inthe

eventof

aclaim

againstsuch

assets.For

asettior

with

criminally

derivedw

ealth,the

trustw

ouldseem

tobe

auseful

weapon

forshielding

propertyfrom

seizure,since

itis

placedoutside

hisow

nership

andco

ntro

l.66

Also,

adebtor

may

seekto

placehis

wealth

safelyaw

ayfrom

creditors

bythe

useof

anoffshore

trust.T

hisis

becausethe

beneficialow

nershipin

trustp

rop

ertyresides

inthe

beneficiariesand

notin

thesettlor/debtor.

Offshore

trustsw

hichare

designedfor

thesole

purposeof

preservingassets

againstclaim

sunder

foreignin

sol

vency,m

atrimonial,

orsuccession

laws

arecom

monly

referredto

asA

ssetP

rotection

Trusts

(AP

Ts).

An

AP

Tm

aybe

usedby

asettlor

who

wishes

toprotect

hisw

ealth

againstclaim

sby

creditorsfor

satisfactionof

adebt,

includinga

judgment

deb

t.67

Also,

itm

aybe

adoptedby

thesettlor

seekingto

excludehis

wealth

fromclaim

sby

aform

erspouse

orchildren

form

aintenanceor

property,or

who

simply

wants

his

propertyto

bedevised

ina

manner

inconsistentw

ithdom

esticsuccession

laws.

Provisions

existin

thetrust

lawof

some

Com

monw

ealthC

aribbeanjurisdictions

which

havethe

effectof

insulatingassets

placedin

offshoretrusts

fromforeign

claimants,

therebyencouraging

theform

ationof

suchA

PTs.

These

provisionshave

the

effectof

making

claims

againstan

AP

Tdifficult,

ifnot

impossible,

tosucceed.

Creditors

seekingto

havethe

trustset

asidein

orderto

establishthat

thebeneficial

ownership

ofthe

propertystill

residesin

thesettlor/debtor,

andthat

theproperty

isthus

availablefor

satisfactionof

thedebt,

will

encounterthe

following

hurdles.

First,the

burdenof

proofis

placedsolely

oncreditors

toestablish

thatthe

disp

osi

tionof

property,w

hereversituated,

was

made

atan

un

derv

alue

65

andw

iththe

intentof

0.

Osborne,

“Asset

Protection

forU

nitedStates

Clients”

(1995)4

Journalof

Ioternatio,tolT

rustand

Corporate

Planning

12.°

Hosvever,

legislationperm

itlingthe

seizureof

theproceeds

ofcrim

eusually

providefor

thetracing

of

suchassets

intothe

handsof

thirdparties,

includingtrustees.

How

ever,it

shouldbe

notedthat

inthe

flahamas

where

atestator

busoutstanding

debtsand

liabilities

anypurported

disp

ositio

uof

hisassets

byw

illw

ouldbe

deemed

voidas

againsthis

creditors.T

heprop.

ertyof

thedeceased

lestatorw

ouldhe

consideredassets

forpaym

entof

thedebts

andthe

courtw

ould

administer

theproperty

forthat

purpose(s.2

lA

dministration

ofE

statesA

ct2002).

68“U

ndervalue”m

eansthe

provisionof

noconsideration

orthot

which

issignificantly

lessthan

thevalue

ofthe

property,for

esample,

s,2

Fraadutent

Dispositions

Law

(1996R

ev.)(“FD

L”)

(Cl.);

s.2

Fraudulent

Conveyances

Act

1991(“FC

A”)

(flab.).T

hisw

ouldinclude

adisposition

forming

thesubject-m

atterof

atrust.

defraudingthat

credito

r.69

Inestablishing

thisclaim

,the

creditorw

ouldhave

toprove

thatin

establishingthe

trust,the

settlorhad

an“intent

todefraud”

him

,7°

thatis,

anintention

to“w

ilfullydefeat

anobligation”

owed

toh

im.

7tB

ycom

?arison,in

theU

Kthere

isno

needto

establisha

specificintent

todeceive

credito

rs,7

Furtherm

ore,the

claimant

must

showthat

suchan

obligationexisted

onor

priorto

thedate

ofthe

disposition,and

thatthe

sen

ior

hadnotice

ofthis

obligationat

thetim

eof

thetran

sfer,73

Therefore,

inorder

tosucceed

theclaim

antm

ustprove

thathe

was

acred

itorat

thetim

eof

thedisposition,

sinceany

transfersexecuted

priorto

thedebt,

evenif

inanticipation

ofit

would

notbe

voidable,A

neven

more

radicalposition

was

adoptedin

theT

urks&

Caicos

Islandsw

herethe

legislationprovided

thata

trustis

notvoidable

atthe

instanceof

acreditor

unlessit

isproved

thatat

thetim

eof

thetrust

thesettlor

was

insolventor

thatthe

dispositionrendered

himinsolvent.

That

is,m

erein

deb

tedness

orfuture

insolvencyw

ouldnot

Vitiate

thed

ispo

sition

.74

This

effectivelysupersedes

theestablished

comm

onlaw

rulein

Re

Butterw

orth

,75

which

allowed

thesetting

asideof

atrust

onthe

groundsof

beingfraudulent,

bycred

itors

whose

debtdid

notexist

atthe

time

ofthe

disposition,but

whose

existencecould

havebeen

anticipatedby

thesettlor.

By

restrictingrights

ofavoidance

tocreditors

existingat

thedate

ofthe

disposition,the

offshoresettior’s

positionis

thusgreatly

improved,

sinceit

allows

himto

createtrusts

which

cannotbe

avoidedby

futurecred

itors.

76

There

alsoexist

relativelyshort

limitation

periodsfor

creditorclaim

s.For

example,

inthe

Baham

as,any

actionsto

setaside

thetrust

must

bebrought

within

two

yearsfrom

thedate

ofthe

transferof

wealth

intothe

trust.

77

By

contrast,in

theU

Kthere

hastraditionally

beenno

time

limit

forsetting

asidea

trustif

theinsolvent

settlor’sd

om

islant

purposein

creatingthe

trust,w

asto

prejudicecred

itors,

78

The

aboveprovisions

arebolstered

bythe

choiceof

lawprovisions

which

enablethe

settiorto

expresslydeclare

inthe

trustthat

thelaw

ofthat

offshorejurisdiction

shallgovern

thetru

st.79

Accordingly,

thelaw

ofthe

placew

herethe

trustin

netup

deter

mines

thevaltdity

andeffect

ofthe

trust,w

hetherthe

trustproperty

involvesm

oveableor

imm

ovablepro

perty

.85

Moreover,

thetransfer

ofassets

toa

trustunder

suchlaw

would

beconsidered

valideven

where

thesenior

isin

ajurisdiction

thatdoes

notrecognise

thetrust

concept.A

ssuch,

anythird

partyclaim

sagainst

thetrust

propertyw

ouldbe

subjectto

thetrust

andfraudulent

dispositionlaw

sof

thehaven

state.A

significantcharacteristic

ofAP

Ts

isthat

theym

ayalso

containflee

clauses.T

heseare

clausesw

hichperm

itthe

changeof

theriots

ofthe

trust,either

automatically

onthe

occurrenceof

aspecified

event,or

atthe

discretionof

thetrustee

ora

thirdparty

Protector.In

suchsituations,

theexisting

trusteew

ouldretire,

newones

would

beappointed,

andthe

assetstransferred

toanother

trustin

adifferentjurisdiction.

Inrelation

For

esample

so.4(1)

and(2)

FDL

(Cl.).

n.2

FCA

(flab.);a.

2FD

L(C

I).‘

Forexam

ples.2

FDL

(CI.).

72T

hatis

becausethe

words

“intentto

defruad”do

notappear

inthe

relevantsection

ofthe

InsolvencyA

ct1986;

seeC

hohane

Sagger

119921B

.C.C

.306.

ss.2

and6

FDL

(Cl.);

so.2

and4

FCA

(Bah

j.s.6

lT

rustO

rdinance(1990).

(1882)19

Ch.

D.

588.G

.K

od

tliny

e,C

aribbeanL

awof

Trusts:

Text,C

ases‘8

MateriaL

s(1996).

a.4(3)

FDA

(Bob);

theC

ayman

Islandsboa

alonger

limitation

periodof

6years

s.4

FDL

(Cl.).

s.423

InsolvencyA

ct1986

(emphasis

mine).

ns.4

(1)

Trusts

(Choice

ofG

overningL

aw)

Act

1989(B

ob.);s.

89T

rustsL

uw(2001

Revision)

(CI.).

87A

tcom

mon

lawthe

rulefor

moveables

isthe

same,

butim

moveables

oregoverned

bythe

lexsitar.

4041

Money

Laundering

Control

inthe

Caribbean

Offshore

Financial

Havens

andM

oneyL

aundering

totrigger

clauses,ft

may

beexpressly

providedthat

thetrust

isto

betransferred

to

anotherjurisdiction

where

acourt

orderthreatens

thefree

disposalby

thetrustees

of

thetrust

property.T

histype

of‘creditor

resistant’clause

isdesigned

toallow

the

beneficiaries(w

hichm

ayinclude

thesettlor),

always

tobe

onestep

aheadof

potential

creditors,thereby

allowing

thetrust

propertyto

remain

elusive.

InP

rivateT

rustC

orporationv.

Grupo

Torras

SA8’

thetrust

deedprovided

forthe

automatic

termination

ofthe

tenureof

thetrustee

uponany

judicialaction,

thepurpose

oreffect

ofw

hichw

asto

restrictthe

freeand

imm

ediatetransfer

oftrust

propertyinto

andout

ofthe

Baham

as.U

ponsuch

cessation,it

was

providedthat

thetrustees

would

bedivested

ofthe

trustproperty,

andthe

trusteeshipsucceeded

toby

anam

edtrustee

incorporatedin

theT

urksand

Caicos

Islands.T

heresult

would

bethe

ousterof

the

jurisdictionof

theB

ahamian

courts.H

erethe

assetsrepresented

theproceeds

ofan

allegedfraud

comm

ittedby

Sheikh

Fahad

ofK

uwait.

The

Court

ofA

ppealof

the

Baham

asrecognised

thatthe

terms

ofthe

trustw

ouldeffectively

renderthe

trustp

rop

ertyjudgm

ent-proofonce

inflight

toan

alienjurisdiction.

Inthese

circumstances

it

was

heldthat

theprovisions

createthe

verykind

ofsituation

which

theM

arevain

junc

tionw

asdeveloped

tocounteract;

thatis,

theflight

offunds

tofrustrate

theexecution

ofa

possibleju

dgm

ent.

82

As

such,it

was

heldthat

apre-em

ptiveM

arevainjunction

was

necessaryto

imm

obilisethe

assetsbeneficially

owned

bythe

Sheikh

andsafe

guardthem

fromflight

underthe

terms

ofthe

trust.T

hisaction

was

deemed

necessary

to‘shut

thestable

doorbefore

thehorse

bolts’83

Nevertheless,

thecase

demonstrates

howA

PTs

canbe

structuredto

trump’

allchallengers,

bykeeping

thetrust

property

outof

theirre

ach

.84

What

ism

oresinister

isthat

theseclauses

may

resultin

them

igra

tionof

trustsw

hichare

potentiallysubject

toseizure

underthe

confiscationlaw

s

beforean

ordercan

beenforced.

Interm

sof

estateplanning,

thegeneral

ruleis

thaton

thedeath

ofa

settlor,trust

propertydoes

notform

partof

hisassets

forprobate

purposes.H

owever,

conflictsm

ay

ariseinvolving

claimants

fromjurisdictions

with

forcedheirship

rules.Such

claims

may

bepursuant

tothe

civillaw

orthe

Shari‘a

(Islamic

law)

which

impose

mandatory

rulesrelating

tothe

testamentary

dispositionof

property.U

nderthe

lexsuccesslonis

of

thesesystem

s,close

family

mem

bersare

statutorilyentitled

toa

specifiedportion

of

thetestator’s

estate.If

theydo

notreceive

theirshare

byw

ill,they

may

applyto

the

courtfor

anorder

settingaside

anyprior

dispositionby

giftso

thatthat

property

retums

tothe

testator’spool

ofassets

fordistrib

utio

n.

85

Since

thecom

mon

lawrecognises

theconcept

offreedom

oftestam

entaryd

ispo

si

tion,there

areno

parallelforced

heirshiprules.

How

ever,som

ejurisdictions

intro

duceddiscretionary

provisionsinto

theirsuccession

laws

which

would

allowthe

unsatisfieddependant

toapply

tothe

courtfor

anorder

forreasonable

provisionout

of

thedeceased’s

esta

te.

86

These

laws

would

enablethe

courtto

quantifythe

valueof

the

estateto

includeany

proprietarydispositions

bythe

deceased(other

thanfor

full

value)if

thecourt

concludesthat

suchdisposition

was

made

with

theintention

of

defeatingany

suchclaim

s.

[1997—981

1O

.F.L.R

.443.

‘Ibid.per

Gonsulves-S

abotaP.

P.M

atthews,

“The

Asset

Protection

Trust:

Holy

Grail

orW

hollyU

seless?’(t995—

6)6

Ktngs

College

Law

Journal62,

D.

Hayton,

“Trusts

andForced

Heirship

Problem

s”(1993—

4)4

Kings

College

Law

Journal12.

96For

insta

nce,

thisw

asachieved

bythe

Inheritance(Provision

for. Family

andD

epnndants)A

ct1975

(England)

andthe

Succession

Act

1980(B

arbados).

Inany

ofthe

abovesituations,

ifthe

assetsare

locatedin

anA

PT

governedby

the

lawof

anoffshore

jurisdiction,it

may

bevirtually

impossible

fora

dependant’sclaim

tosucceed.

Indeed,w

ithrespect

toclaim

antsfrom

aforced

heirshipjurisdiction,

Caym

anianlaw

specificallyexcludes

anysuch

claims

throughits

non-recognitionof

forcedheirship

rights.

87

Thus,

notrust

will

beset

asideon

thebasis

thatit

defeats

interestsconferred

byforeign

successionlaw

s.D

ishonestsettlors,

with

theaid

ofequally

unscrupuloustrustees,

may

engagein

anarrangem

entby

which

thetrustees

recognisethat

theassets

remain

thesettlor’s

in

allbut

name,

sadthat

theirtask

isto

doexactly

asthe

settlorsa

ys.

88

That

is,there

isno

realtrust,

sincethe

settiorw

ouldalw

aysbe

infull

controlof

thetrust

property.In

such

asituation,

aclaim

antseeking

toset

asidethe

trustw

ouldhave

totry

toestablish

that

thetrust

isa

sham.

InR

ahman

v.C

haseB

ank(C

I)T

rustC

o.L

td.

89

thew

idowof

the

settlorbrought

anaction

againstthe

offshoretrustee

seekingto

setaside

thepurported

settlement,

sinceit

was

inviolation

ofheirship

laws.

Itw

asheld

thatthe

trustw

as

asham

,since

itappeared

tobe

what

itw

asnot.

Here

thesettlor

breachedthe

cardinal

ruleof

avalid

trustby

continuingto

treatthe

trust’sassets

ashis

own,

andthe

trustee

ashis

nominee

oragent.

The

factsin

thatcase

were

peculiarin

that,from

them

oment

ofthe

disposition,the

settlorexercised

complete

controland

authorityover

thetrustee

inthe

managem

entand

administration

ofthe

pretendedsettlem

ent,including

distrib

u

tionsof

capitalto

himself.

Aprovision

inthe

Caym

anIslands

trustlegislation

would

make

iteven

more

diffi

cultto

provethat

thetrust

isa

sham.

This

isbecause

thesettlor

isallow

edto

reserve

sayor

allof

thefollow

ingpow

ers:to

revoke,vary

oram

endthe

trustinstrum

ent;

appointincom

eor

capital;act

asa

directorof

acom

panyow

nedby

thetrust;

instruct

thetrustee

inrelation

tothe

investment

ofthe

trustproperty;

appointor

remove

any

trustee,protector

orbeneficiary;

andchange

thegoverning

lawor

forumfor

thetrust’s

adm

inistratio

n.

95

Inaddition,

thesettlor

isallow

edto

reserveany

limited

beneficial

interestin

thetrust

property.In

most

casesw

herethe

settior’saim

ism

erelyto

facilitatethe

transferof

illicit

wealth,

hew

illretain

asignificant

amount

ofcontrol

throughnon-binding

lettersof

wishes

orby

theappointm

entof

aP

rotectorto

guidethe

trustee.In

anextrem

eform

,

alaunderer

may

exercisecontrol

byestablishing

hisow

noffshore

trustcom

panyto

act

astru

stee.9’

Whilst

thelegal

technicalityfor

separationof

ownership

andcontrol

from

thesettlor

would

besatisfied,

insubstance

thetrustee

will

merely

beacting

underthe

authorityof

thesettlor/Jaunderer.

Alternatively,

theshares

ofthe

offshorecom

pany

may

beheld

bythe

offshoretrust,

with

thesettlor/launderer

beingm

adechief

op

er

atingofficer

ofthe

company

with

theauthority

todraw

fundsand

payhim

self,thereby

allowing

himcontrol

overthe

trustasse

ts.92

Inthe

contextof

money

laundering,one

might

askw

hereon

thelegal

spectrum

avalidly

createdA

PT

lies.To

theextent

thatthe

propertyw

asacquired

throughleg

iti

mate

means,

onem

aysay

thateveryone

hasthe

rightto

enhanceand

preservepersonal

wealth

throughlaw

fulactivities.

Nevertheless,

where

thesetrusts

havethe

effectof

undermining

oreven

defeatingthe

insolvency,m

atrimonial

orsuccession

laws

of

as.90

to92

Trusts

Law

(2001R

ev.).A

.E

dwards,

Review

of Financial

Regulation

inrIte

Crow

nD

ependencies(1998).

9°[19911

J.L.R

.103.

9°a.

14T

rustsL

aw(2001

Rev.).

9IA

trustcom

panycan

beset

uppursuant

tothe

laws

regulatingthe

licensingof

offshorebanks

for

example,

BT

CL

(CI.);

BT

CA

(flub.).92

UNLICP,F

inancialH

avens,B

ankingS

errecyand

Money

Laundering

(1998).

4243

Money

Laundering

Control

inthe

Caribbean

Offshore

Financial

Havens

andM

oneyL

aundering

anotherjurisdiction

anddenying

thosew

itha

‘legitimate

expectation’of

claiming

againstsuch

property,the

secretionof

wealth

intoan

offshoretrust

sitsuneasily

on

thebenchm

arkbetw

eenthat

which

islaw

fuland

thatw

hichis

unlawful.

Of

course,the

greatercause

forconcern

isthe

potentialuse

ofA

PT

sfor

thepurpose

oflaundering

the

proceedsof

seriouscrim

es.A

spointed

outby

astudy

onfinancial

regulationin

theoffshore

dependencies,the

scopefor

theabuse

ofoffshore

trustsis

con

siderab

le.93

This

stems

fromtheir

abilityto

concealcrim

inalproceeds

byhiding

theidentity

ofthe

settlorand

beneficiaries.E

venif

discovered,the

trustassets

canstill

bekept

outof

the

reachof

foreignauthorities,

with

theaid

ofshort

limitation

periodsand

fleeclauses.

Overall,

theeffect

ofA

PT5

isindeed

worrying,

bym

akingit

“impossible

forforeign

lawenforcem

entauthorities

toquestion

whether

thetrust

hasbeen

establishedw

iththe

proceedsof

crime

andim

possibleto

recoverthe

fundsif

infact

ith

as”

.94

SEC

RE

CY

OF

OPE

RA

TIO

NS

One

ofthe

most

attractivebenefits

ofconducting

financialbusiness

inthe

offshore

world

isthe

protectionof

financialprivacy

rights.It

hasbeen

saidthat

“regardlessof

why

legitimate

andillegitim

atebusinesses

gooffshore,

thecom

mon

denominator

is

thatboth

want

secrecy,discretion

andco

nfid

entiality

”.95

The

confidentialitylaw

sin

theoffshore

jurisdictionsvary

indegree

ofstrictness

andapply

notonly

inthe

co

nte

xt

ofbank

secrecy,but

alsoinclude

corporateand

trustlaw

sw

hichprotect

theidentity

of

thetrue

owners.

Confidentiality

hasalw

aysbeen

particularlyattractive

tothose

who

considerthat

theirdom

esticrights

toconfidentiality

havebeen

undermined,

orthat

theirproperty

is

threatenedby

ahostile

confiscatorygovernm

ent.In

thisrespect,

them

odemprototype

ofbanking

confidentialityem

ergedin

the1

93

0s,

96

when

theSw

issgovernm

entco

di

fiedan

existingpractice

ofbanking

secrecyand

renderedviolations

ofthe

secrecy

provisionsa

crim

e.

97

This

measure

was

aimed

atpreventing

Nazi

agentsfrom

pursuing

andseizing

assetsbelonging

toG

erman

Jews.

Inthe

Caribbean,

financialsecrecy

has

beenone

ofthe

main

featuresof

theoffshore

sector.Indeed,

thesecrecy

attachedto

relationsand

transactionsbetw

eenfinancial

institutionsand

theirclients

hasbeen

consideredessential

forthe

attractionof

financialbusiness,

Ithas

beenfelt

that“any

lesseningof

thisguarantee

would

harmthe

interestsof

the[region]

andany

streng

th

eningof

itw

ouldbolster

them

”.

98

How

ever,the

secrecyhaven

hasalso

beenone

ofdirty

money’s

“most

cherished

privilegesan

d..,

ardentso

licitors”.

99

Crim

inalsrely

onsecrecy

laws

tocom

mit

crimes

because,quite

simply,

evenafter

thosecrim

eshave

beendiscovered,

secrecylaw

s

substantiallyinterfere

with

legitimate

lawenforcem

entand

bankregulators

tod

eter

mine

who

perpetratedthe

illicitactivity

andw

herethe

money

went.

AR

eportof

the

A.

Edw

ardsop.

cit.ibid.H

LB

arber,T

arH

avens,H

owto

Bank,

investand

Do

,Business.O

ffshoreand

TaxFree

(1993).

The

model

adoptedin

most

Caribbean

offshorejnrisdtctlons.

JH

orowitz,

“Piercing

Offshore

Bank

SecrecyL

aws

Used

toL

aunderIllegal

Narcotics

Prolits:

The

Cayrnan

islandsE

nample”

(1985)20

Texas

inrernatiol,alL

ao’Journal

133.

Donald

Fleming,

former

President

ofthe

Bask

ofN

ovaS

cotiaT

reatC

o.(B

ahamas)

isa

speechto

the

Baham

ianC

hamber

ofC

omm

ercein

1977,quoted

inH

.E

rbstein,“B

askS

ecrecyL

owand

its

Implications

forA

mericnn

SecnritieaR

egulation”(1995)

16C

ompany

Law

yer133.

AM

aingot,“B

uckingthe

Trend

—O

ffshoreSecrecy

Centres

andthe

Role

ofG

overnment”

(Jane1996)

Cariconi

Perspective

32.

US

Departm

entof

Treasury

concludedthat

oneof

them

ajorbarriers

todealint

effectivelyw

ithabuses

inoffshore

financialjurisdictions

isthe

inabilityof

investiga.m

rsto

obtainusable

information

with

respectto

transactionsconducted

inor

througithose

havens.

t5

0T

hisis

becauseeven

when

casesof

abuseare

identified,prosecutior

isdifficult,

ifnot

impossible,

asa

resultof

thetransactions

takingplace

througha

offshorebank,

trustor

corporation,C

onfidentialitym

aybe

achievedin

many

ways

andthe

specificdevices

utilisedin

many

ofthe

jurisdictionsw

illbe

examined

intht

following

subsections.

Public

Records

First,confidentiality

may

beprotected

byrestrictions

onthe

typeof

information

available

inpublic

registries.T

helatter

areusually

thefirst

stopin

aninvestigator’s

questsince

theygenerally

revealdata

onthe

ownership

andfinancial

activitiesof

legalenti

tiesregistered

inthat jurisdiction,

Fora

money

launderinginvestigation,

detailson

thiregistration

ofcorporate

entities,their

beneficialow

nershipand

financialactivitie:

would

providea

usefulstarting

point.H

owever,

accessto

suchinform

ationis

limitet

bythe

provisionsin

theoffshore

trustand

company

legislationw

hichperm

itthi

disclosureof

minim

alinform

ationO

ntopublic

records,For

example,

inthe

Baham

as,although

thereis

arequirem

entfor

anIB

Cto

keela

shareregister

atits

registeredoffice,

thereis

norequirem

entto

lodgeit

with

thR

egistrarof

Com

pan

ies.t5t

Records

ofthe

company’s

business,including

minutes

om

eetingsand

resolutions,as

well

asregisters

ofdirectors,

may

bekept

bythe

compan’

atits

office,but

thereis

norequirem

entfor

themto

belodged

with

thepubli

reg

istry.

t02

Mem

bersof

theIB

Cm

ayrequest

inspectionof

booksif

itis

fora

purposrelated

tothat

mem

ber’sinterest

inthe

company,

butit

isin

thecom

pany’sdiscretioi

torefuse

suchrequest

ifit

deems

itnot

inthe

bestinterest

ofthe

com

pany.

t03

ItC

ayman,

anexem

ptcom

panyis

notrequired

tofile

anannual

returnof

itsfinancia

dealingsor

ofits

mem

bersw

iththe

Registrar

ofC

om

panie

s,T

hus,the

financiaactivities

ofthe

company,

includingdetails

aboutthe

assetsand

sharecapital,

may

bkept

hidden,A

lso,although

requiredto

keepa

registerof

shareholders,’°5

exemp

companies

areperm

ittedto

keepsuch

registeranyw

herein

thew

orld.106

Further,

thnam

esof

officersand

shareholdersin

thecom

panym

ayrem

ainSecret

asthe

exemp

company

isnot

obligedto

permit

publicinspection

ofits

record

s.t5

7In

UJB

Financial

Corporation

v.C

’hilntarkO

ffshoreC

apitalF

undL

td,

t55

thC

ayman

IslandsG

randC

ourthad

todeterm

inew

hetherthe

defendantcom

pany’register

ofshareholders

was

confidentialinform

ationw

ithinthe

meaning

ofth

Confidential

Relationships

(Preservation)

Law

(“CR

PL

”))°9

That

lawapplies

to“a)

confidentialinform

ationw

ithrespect

tobusiness

ofa

professionalnature

which

arise

tOU

SD

epartment

ofT

reasury,R

eporton

TaxH

avensin

riteC

aribbean(1985).

s.29

IBC

Act,

t2a.

66tB

CA

cLa.

67IB

CA

ct.n.

41C

ompanies

Law

(20012nd

Rev.).

as.40(1)

and41(1)

ibid.s.4

45?

‘°[1992—

3]C

.I.L.R

.53.

09If

itw

ereconstrued

ussuch,

thenin

theabsence

ofconsent

fordisclosure

bythe

defendant,the

coaw

onldbe

requiredto

considerw

hetherdisclosure

coaldbe

orderedon

thebasis

ofone

ofthe

statutotenem

ptions.

5393569999I

4445

Money

Laundering

Control

inthe

Caribbean

Offshore

Financial

Havens

andM

oneyL

aundering

inor

isbrought

intothe

Islandsand

toall

personscom

inginto

possessionof

such

information

atany

time

thereafterw

hetherthey

bew

ithinthe

jurisdictionor

thereo

ut”.°

5H

erethe

defendantcom

panyw

asfounded

inthe

BV

I,but

itspnncipal

placeof

businessw

asthe

Caym

anIslands.

Itw

asadm

inisteredby

aC

aymanian

company

which

maintained

aregister

ofthe

defendant’sshareholders.

The

courtheld

thatthe

registerof

thedefendant’s

shareholdersw

asconfidential

information

within

thescope

ofthe

Law

,and

sodisclosure

ofthe

shareholders’nam

escould

onlybe

made

ifthe

plaintiff’sapplication

fellw

ithinone

ofthe

statutoryg

ateway

s)”

Insom

ejurisdictions,

evenif

accessto

theshare

registeris

achievedthe

sharesare

likelyto

bein

thenam

esof

nominees,

therebyconcealing

theidentity

ofthe

real

owners.

Furtherm

ore,if

bearershares

were

issued,there

couldbe

norecord

ofthe

presentshareholders

ofthe

company.

As

isthe

situationin

many

jurisdictions,the

absenceof

arequirem

entto

fileregular

financialstatem

entsor

theregular

monitoring

ofa

company’s

businessallow

ssom

eoffshore

companies

toexist

asa

mere

shell.

Conversely,

acom

panyregistered

foronshore

business,w

hichis

notfunctional,

could

bestruck

offfor

inactivity.

There

isoften

norequirem

entto

registera

trustor

filea

copyw

itha

government

authority.F

urther,unless

authorisedby

thetrust

instrument

orordered

bythe

courtto

doso,

thetrustee

may

bespecifically

precludedfrom

disclosingto

anyperson

info

r

mation

relatingto

thesettior,

beneficiaryor

thetrust

accou

nts.’

t2

InC

ayman,

although

theinstrum

entof

anexem

ptedtrust

islodged

with

theR

egistrarof

Trusts,

itis

not

opento

publicinspection

orexam

inationby

anyoneother

thanthe

trusteesand

those

expresslyauthorised

bythe

trustin

strum

ent.

tt3

Inany

event,by

virtueof

theco

nfid

en

tialitylaw

sin

theC

ayman

Islands,any

information

givento

theR

egistrarof

Trusts

is

confidentialand

may

notbe

disclosedby

thatoffice

unlessunder

oneof

theestab

lishedcriteria

fordisclo

sure.”

4

Banking/F

inancialC

onfidentiality

Inthe

Caribbean

offshorew

orld,banking

secrecyhas

beenview

edas

aprerequisite

for

thesurvival

ofthe

financialindustry

andindeed

theeconom

ythat

itupholds.

AB

ahamian

Chief

Justicevoiced

thisbelief

when

hestated

that“...

thesecrecy

pro

vi

sionis

oneof

thepillars

ofthis

partof

oureconom

icstructure,

thedestruction

of

which

would

leadto

thecollapse

ofthe

whole

structureit

supports.hiS

Through

itsrole

aspayer

andreceiver

ofa

customer’s

money,

abank

hasaccess

to

intimate

detailsregarding

itscustom

ers’financial

transactions.B

anksecrecy

laws

thereforeexist

toprotect

theconfidentiality

ofinform

ationheld

byfinancial

institu

tions.E

ssentiallythey

prohibitthe

disclosureby

banksof

acustom

er’sidentity,

bu

si

nessrecords

andother

detailsrelating

10the

bankaccount

exceptin

clearlydefined

circumstances.

o5.3

(l)C

RI’L

.T

hesestatutory

gateways

will

bediscussed

below.

Inihe

insisntcsse

disclosurew

asdenied

asthe

opplicationappeared

tobe

afishing

expeditionfor

thepurpose

ofascestalning

whether

therew

asa

busixfor

theforeign

proceedingsto

which

itrelated.

2See

forexam

ples.

83(5)T

rusteeA

nt1998

(Bah.);

s.3

CR

PL

(Ct.).

113v.

77

Trusts

Low

(2001R

ev.).T

insm

oyinclude

aProtector.

These

will

bediscussed

laterin

thechapter.

ss.2

and5

CR

PL

resdrr

ita

crime

fora

publicor

go

vern

ment

officisi,such

asthe

Registrar

ofC

ompanies

orT

rusts,to

discloseany

information

obtainedin

thatcapncity

unlessauthorised

sodo

soby

virtueof

thesectiod

3exem

ptionsor

pursuantto

anorder

of

the

con

rt.

perK

nowles

Ci

Re

Nassau

Dank

andT

rustC

ompany

11977—8)

1L

.R.B

.I.

Incivil

lawjurisdictions,

theconcept

offinancial

privacyis

consideredto

be

acentral

tenetof

individualrights

andfreedom

s.C

omm

onlaw

countriesrecognise

anim

pliedterm

inthe

banker/customer

contractw

hichprecludes

disclosureof

the

customer’s

financialdetails.

The

comm

onlaw

dutyof

confidentialitybetw

eenbanker

andcustom

eras

laiddow

nin

Tournier

v.N

ationalP

rovincialand

Union

Bank

of

Engla

nd

116

isa

partof

thelaw

ofthe

Com

monw

ealthC

aribbean.In

accordancew

ith

theT

ournierprinciples,

acustom

erhas

theright

tosue

hisbanker

fordam

agesfor

breachof

contractw

herethe

bankerdiscloses

information

relatingto

thecustom

erin

circumstances

outsidespecific

permitted

parameters.

Afinancial

institutionm

ayonly

revealinforrnalion

relatingto

itscustom

erw

here:(i)

thebank

isacting

underco

mpu

l

sionof

law;

(ii)the

bankis

actingunder

aduty

tothe

publicto

disclose;(iii)

thein

ter

estsof

thebank

requiredisclosure;

or(iv)

thecustom

erhas

expresslyor

impliedly

consentedto

disclosure.T

heseexisting

rightsto

financialprivacy

havebeen

buttressed

bythe

criminal

lawin

some

offshorehavens.

By

criminalising

breachesof

theco

nfi

dentialityprovisions,

thesejurisdictions

havegiven

statutoryeffect

tothe

strongpublic

interestinherent

inm

aintainingone

ofthe

pillarsof

theireconom

y.In

doingso,

they

havealso

made

themselves

more

attractiveto

criminals

who

craveanonym

ity.

Inthe

Baham

as,it

isa

criminal

offencefor

anyperson

who

hasacquired

info

rma

tionin

hiscapacity

asa

director,officer,

employee,

agentor

former

licenseeof

abank

ortrust

company

todisclose

toany

otherperson

anyinform

ationrelating

to

acustom

er’sidentity,

assets,liabilities,

transactionsor

accounts.

t17

Likew

ise,in

the

Caym

anIslands,

theconfidentiality

laws

renderit

acrim

inaloffence

fora

personin

possessionof

confidentialinform

ation,how

everobtained,

todivulge

itor

toattem

pt,

offeror

threatento

divulgeit

orfor

aperson

tow

ilfullyobtain

orattem

ptto

obtain

confidentialin

form

ation.”t

Suchconfidential

information

refersto

information

which

therecipient

isnot

authorisedby

theprincipal

todisclose,

otherthan

incarrying

out

theinstructions

ofthat

principal,and

includesinform

ationgiven

toa

publicofficial,

abanker,

trusteeor

attorney-at-law.

Itis

suchstrict

banksecrecy

laws

which

allowed

fornum

beredbank

accounts,w

hereonly

seniorm

anagement

knewthe

identityof

theaccount

holder,and

gavethe

Caym

anIslands

thenicknam

e‘G

enevaof

the

Carib

bean

’.1’9

Since

lawyers

areresponsible

forsetting

upoffshore

financialentities

onbehalf

of

clients,and

areofle

nchosen

asthe

nominee

directorsfor

suchoffshore

companies

or

asthe

residentagents

foroffshore

banks,the

issueof

legalprofessional

privilege

arises,it

may

presentan

impedim

entw

herelaw

enforcement

seeksto

gainaccess

to

information

aboutthese

entitiesfrom

thelaw

yer.L

egalprofessional

privilegeattaches

toall

comm

unicationsbetw

eena

lawyer

andclient

forthe

purposeof

givingor

obtaininglegal

advice,even

where

litigationis

notco

ntem

plated

.12°

Breach

ofthis

duty

couldexpose

theattorney

toliability

tohis

clientfor

dam

ages.’

2’A

sin

theB

ahamas,

[192411

KB

.46t.

s.15

ET

CA

Contravention

ofthis

sectionsvoutd

resultis

afine

ofup

toB

ah.$25000

orim

prisonment

fora

periodnot

exceeding2

yesrs,or

both.

s.5C

RP

L.

‘‘

J.R

obinson,T

heL

.aundryrnen—

Insidethe

World’s

Third

Largest

Business

(1994).

20per

Miiiett

3.P

riceW

aterhousev

BC

CI

Holdings

(Luxem

bourg)SA

[19921B

.C.L

.C.

583.

InInterna,ional

Credit

andinvesi,nent

Co.

(Orersens)

Ltd

s’. Adham

TheT

imes,

February

10,1997

it

was

heldIhut

thecourt’s

inherentpow

erto

orderu

solicitorto

discloseIhe

name

nndaddress

ofhis

clientshould

beexercised

onlyin

exceptionsleases.

Here

itw

ouldbe

asedto

preventdefendants

inan

inlernationslfrond

fromdefeating

thejurisdiction

ofthe

courtthrough

“shadowy

offshoreIrusis

sad

companies

which

were

designedio

make

theirassets

‘judgment.proof’

46

47

Money

Laundering

Control

inthe

Caribbean

Offshore

Financial

Havens

andM

oneyL

aundering

theconfidentiality

laws

may

alsoim

posecrim

inalliability

onthe

attorneyw

hodivulges

confidentialinform

ationabout

hisclient’s

propertytran

sactions.’

22

Aduty

ofconfidence

alsoarises

where

therein

atrust

orfiduciary

relationshipin

existence,so

thatthe

oneto

whom

theduty

isow

edm

ayseek

injunctiveor

remedial

relieffrom

thetrustee/fiduciary

where

thelatter

purportsto

breachthat

confidence.

Additionally,

thetrustee

may

fallw

ithinthe

ambit

ofthe

confidentialitylaw

s.In

Re

H’

23

itw

asheld

thatsince

theapplicant

trusteew

asin

theposition

ofa

personto

whom

confidentialinform

ationw

asim

partedduring

thetransaction

of“business

of

aprofessional

natu

re”,’2

4that

is,the

successionto

trusteeship,he

fellsquarely

within

theprovisions

ofthe

confidentialitylaw

sof

theC

ayman

Islands.C

onsequently,he

had

toseek

thedirections

ofthe

courtbefore

divulginginform

ationpertaining

tothe

trusts.

PEN

ET

RA

TIN

GT

HE

WA

LL

OP

SECRECY

The

internationalcom

munity

haslong

condemned

theuse

offinancial

secrecyto

impede

theefficient

investigationof

am

oneylaundering

offence.T

he1988

United

Nations

Convention

Against

IllicitT

rafficin

Narcotic

Drugs

andP

sychotropic

Substances

(the“V

iennaC

onvention”)has

establishedthat

inthe

specificcontext

of

drug-relatedm

oneylaundering,

noparty

shoulddecline

torender

mutual

legalassis

tanceon

theground

ofbanking

secrecy.’

25

Furtherm

ore,the

FAT

Fhas

recomm

ended

thatfinancial

secrecylaw

sshould

beconceived

soas

notto

inhibitthe

implem

entation

ofits

recomm

endationsfor

counteringm

oneylau

nd

ering

.’26

Itis

generallyaccepted

thatpersons

transactingbusiness

with

banksand

otherfin

an

cialinterm

ediariesare

entitledto

areasonable

degreeof

privacyin

connectionw

ith

suchtransactions.

How

ever,the

criticalquestion

isnot

whether

acountry

hasfinancial

secrecylaw

s,but

“whether

thecountry

hasbuilt

intoits

laws

effecttveand

efficient

means

ofpiercing

banksecrecy

where

thereis

areasonable

suspicionthat

abank

accounthas

beenused

inconnection

with

crime

oras

thedepository

ofthe

proceedsof

acrim

e”’

27

Inresponding

tothis

question,one

must

firstconcede

thatthere

isno

such

thingas

absolutebanking

secrecy.’

28

Itis

am

ythand

thereality

isthat

thereexist

built-instatutory

gateways

throughw

hichinform

ationm

ayflow

,as

well

asother

investigativem

eansfor

penetratingthe

perceivedw

allof

secrecy.It

isthe

adequacyof

suchchannels

thatrem

ainsa

moot

point.

Inthe

Baham

as,w

herethe

customer

doesnot

expresslyor

impliedly

consentto

disclosure,the

legislationperm

itsdisclosure

ofconfidential

information

onthe

following

gro

unds.’

29

First,confidential

information

may

berevealed

forthe

purposeof

theperform

ance

ofone’s

dutiesor

exerciseof

functionsunder

thebanking

legislatio

n.’

30

Secondly,

disclosurem

aybe

made

when

lawfully

requiredto

doso

bya

Court

ofcom

petentjurisdiction

within

theB

aham

as.’3’

How

ever,in

thisregard,

aB

ahamian

courtw

illnot

permit

fishingexpeditions,

andin

practicew

illonly

grantan

orderperm

ittingd

isclosure

ofconfidential

information

where

therequest

isspecific.

InN

issanM

otorC

orp.to.

Ad

esco’

32

theS

upreme

Court

refusedto

entertainan

applicationfor

theproduction

ofdocum

entsand

sworn

testimony

foruse

ina

foreigncivil

suit,w

hereit

was

allegedthat

theproceeds

offraud

were

depositedin

aB

ahamian

offshorebank

account.In

thatcase

itw

asheld

thatalthough

thecourt

would

notallow

Baham

iansecrecy

laws

tobe

usedas

ascreen

forfraud,

itw

ouldnot

granta

requestw

hichm

erely“leads

toa

trailof

enquiryto

uncoverprobative

material”.

That

is,som

ethingm

orethan

mere

inferencespointing

inthe

directionof

fraudis

neededto

justifya

courtorder

fordisclosure

ofconfidential

info

rmatio

n’

33

Thirdly,

disclosureis

permitted

ifrequired

underthe

provisionsof

anyother

Baham

ianla

w.t

34

The

latterexception

would

embrace

theprovisions

ofthe

Proceeds

ofC

rime

Act

2000w

hichm

andatesthe

revelationof

otherwise

confidentialbank

information.

As

will

beshow

nin

subsequentchapters,

thisA

ctrequires

thereporting

ofknow

ledgeor

suspicionof

money

laundering,in

certaincircum

stances,w

hilstspecifically

exempting

thediscloser

fromcivil

orcrim

inalliability

forbreach

ofany

non-disclosurerestrictio

ns.’

35

Fourthly,disclosure

may

bem

adeto

aperson

with

aview

tothe

institutionof,

orfor

thepurpose

of,crim

inalor

disciplinarypro

ceedin

gs)

36

Inrelation

tothe

latter,these

may

bein

relationto

proceedingsinvolving

theexercise

ofprofessional

dutiesby

anauditor,

accountantor

attorn

ey,’

37

orthe

dischargeof

dutiesby

apublic

officeror

mem

berof

theC

entralB

ank.’

38

The

confidentialityprovisions

donot

precludethe

Inspectorof

banksand

trustcom

paniesfrom

sharing,w

iththe

Financial

IntelligenceU

nit,inform

ationrelating

toaccounts

andcustom

ersof

alicensee,

where

hebelieves

thata

suspicioustransaction

reportw

asnot

filed.t

39

Additionally,

disclosureis

allowed

where

sucha

rightexists

atcom

mon

law

.’4°

This

would

incorporatethe

basesfor

disclosureset

outin

theT

ourniercase,

andw

ouldcover

theright

todisclose

ifit

isin

thepublic

interestto

doso.

InD

ouglasv.

Pin

dlin

g’

4’it

was

heldthat

ifthe

publicinterest

appearedon

goodgrounds

torequire

disclosureof

acustom

er’sbanking

records,the

customer’s

rightto

non-disclosurew

ithoutconsent

must

yieldto

thepublic

interest.In

thatcase,

theP

rivyC

ouncilconcluded

thatit

was

justifiablefor

acom

mission

ofinquiry

todecide

toinvestigate

therespondent’s

bankingrecords,

where

thisw

asnecessary

toprom

otethe

inquiryinto

whether

ornot

therespondent

hadreceived

anybenefits

orfavours

inconnection

with

thetransactions

inquestion.

Inthis

respect,disclosure

would

alsobe

permitted

where

thebank

isacting

undercom

pulsionof

law.

How

ever,w

heresuch

compulsion

emanates

froma

foreigncourt

or

s.t5(t)(f)(iii)

ET

CA

.132

11989—901

1L

.R.B

.4t2

.133

perG

onsatves-Sabola

AcIg

CJ.

s.t5(t )(f)(iii)

BT

CA

.F

orexam

ple.s.

43.

136S.

t5(t)(v

)B

TC

A.

Suchproceedings

may

bew

ithinor

outsideof

theB

ahamas.

us.t5(t)(v)(A

)and

(B)

BT

CA

.39

I40t5(7)(c).

141s.

t5(7)(a).[1996]

48W

.t.R.

2627

12520

22s.

15(c)B

TC

A.

27[1996)

C.I.L

R.

238.s.3

(I)C

RPL

.‘°

Article

7(5).R

ecomm

endation2

(t996).U

SS

enneR

eport,C

rime

andSecrecy:

The

Use

ofO

ffshoreB

anksand

Com

panies(1985).

PM

aynard‘O

ffshoreB

ankingSecrecy:

Myth

orR

ealily?”(1998)

1Jo,its,a!

ofM

oneyL

auodertng

Control

316.Such

consentis

notrequired

where

ioformalion

isbeing

sharedbetw

eena

licenseeand

Saperntsory

Authorities

forpurpose

ofconsolidated

supervisionor

facilitatingco.opecation

between

domestic

regalaloryauthorities

(ss.15(5)

and(6)

BT

CA

).

As

well

asfor

theperform

anceof

on

esduties

within

thescope

ofone’s

employm

entss.

15(1)(fi)

and

(ii)B

TC

A.

4849

Money

Laundering

Control

inthe

Caribbean

Offshore

Financial

Havens

andM

oneyL

aundering

administrative

order,the

domestic

courtm

aychoose

todeny

disclosure.In

Re

Bank

of

Am

eric

at42

theapplicant’s

headoffice

inthe

US

was

servedw

ithan

IRS

surnntonsto

producebank

recordsof

customers

atthe

Nassau

branch.T

hebank

soughtthe

perm

is

sionof

theB

ahamian

courtto

comply

with

theorder.

Inrejecting

theapplication,

Gonsalves-S

abolafound

“now

arrantfor

regardingcom

pulsionof

lawin

thealien

jurisdictionof

theH

eadO

fficeas

beingcom

prehendedin

thecom

pulsionof

laww

hich

Thurnier

recognisedas

constitutingan

exceptionto

theduty

ofconfidence

owed

bya

localbank

toits

customer”.

Although

atcom

mon

lawthe

bankis

allowed

todisclose

customer

information

insofaras

itis

necessaryto

protectthe

bank’sinterests,

inR

eB

ankof A

merica’

43

it

was

heldthat

thisexem

ptionw

ouldnot

availthe

Baham

ianbank

actingin

responseto

foreignprocess.

Generally,

disclosurew

ouldreasonably

benecessary

toprotect

the

bank’sinterests

asagainst

theircustom

eror

thirdparties

inrespect

oftransactions

of

thebank

foror

with

theircustom

er,or

forprotecting

thebank

orpersons

interested

againstfraud

orcrim

e,In

thiscase,

itw

asthe

court’sopinion

thatif

thebank

made

disclosure,it

would

beunilaterally

relievingitself

ofthat

most

sensitiveof

itsco

ntrac

tualobligations,

non-disclosurew

ithoutthe

customer’s

consent.

Inthe

Caym

anIslands,

confidentialinform

ationm

ayonly

bedisclosed

ifauthorised

todo

soby

theperson

who

hadim

partedthe

info

rmatio

n,’

44

bya

professionalperson

actingin

thenorm

alcourse

ofbusiness,

orby

orto

theF

inancialSecretary,

Inspector

ofF

inancialS

ervicesor

theG

overnorof

thete

rritory

.t45

Otherw

ise,the

seeking,

divulgingor

obtainingof

confidentialinform

ationby

orto

aninvestigator

intom

oney

laundering,m

aybe

achievedin

thefollow

ingspecified

circumstances.

First,pursuant

toa

policeinvestigation

ofa

crime

comm

ittedw

ithinthe

jurisdictionor

ifnot,

ifsuch

actsw

ouldhave

constituteda

crime

within

thete

rritory

.t46

Strictiyspeaking,

thelatter

provisionw

ouldexclude

theobtaining

ofinform

ationin

matters

involvingtax-

relatedm

oneylaundering,

sincetax

evasionis

nota

crime

inthe

Caym

anIslands.

Secondly,w

herea

bankuses

theinform

ationin

anyproceedings

tothe

extentthat

it

isreasonably

necessaryfor

theprotection

ofits

interests,either

asagainst

its

customers

oras

againstthird

partiesin

respectof

transactionsof

thebank

for,or

with,

itscu

stom

er.’47

InR

eB

ankAnserica

Trust

andB

ankingC

orporation(C

ayman)

Ltd

.”58

theG

randC

ourtof

Caym

anheld

thatthis

exceptiondid

notoperate

soas

toenforce

processem

anatingfrom

anotherjurisdiction,

which

soughtto

compel

theproduction

oftransaction

recordsm

aintainedby

thebank

atits

Caym

aniansubsidiary.

This

was

so

eventhough

failureto

comply

couldexpose

thebank

tocontem

ptsanctions

inthe

US

.’49

Therefore,

abank

cannotrely

onthis

exceptionm

erely‘to

saveits

own

skin’

142U

nreportedN

ovember

24.1993,

ibid.a

s.3(2)(b)(i)

CR

PL.

5.3(2)(b)(iv)

CR

PL.

146ss.

3(2)(b)(ii)and

(iii)C

RPL

.

s.3(2)(b)(v)

CR

PL.

146(1992—

3]C

.J.L.R

.574

This

was

atax

relatedm

atterand

inexercising

itsdiscretion

toperm

itor

refase

disclosurethe

Caym

aniancourt

heldthat

thepreservation

ofconfidentiality

outweighed

theinterests

of

theU

SInternal

Revenne

Service

inesforcing

itssum

mons.

‘T

hisapproach

may

becontrasted

with

thattoken

bythe

US

jadiciaryin

theB

ankof

Nova

Scotiacases,

where

itw

asconclsded

thatthe

bank’sfailure

tocom

plyw

ithsubpoenae

toissue

bankrecords

would

amount

toa

contempt

ofcourt,

eventhough

todo

sow

ouldam

onxtto

aviolation

ofoffshore

confiden

tialitylaw

s.T

heirreasoning

was

thatthe

United

States’interest

incollecting

revenuesand

ensuringan

unimpeded

andeflicacioss

investigationoutw

eighedthe

Caym

antslsnds’

interestin

protectingprivacy

rightsunder

itsconfidentiality

laws.

t/Sv.

Ba,,k

of Nova

Scotia740

P.24817

(1984).

sinceit

would

hardlybe

assertinga

legalright

vis-à-visits

customer.

InR

eB

CC

I

(Overseas)

Ltd

)3°

itw

asheld

thatafo

rtiori

thisexem

ptiondid

notapply

where

there

waa

am

ererequest

bya

foreigncourt

notbacked

bylegal

Sanction.M

oreover,in

that

caseit

was

heldthat

theexception

doesnot

coverthe

situationw

herea

bankw

ishes

todisclose

confidentialinform

ationto

thirdparties

foruse

inforeign

proceedingsin

which

thatbank

isnot

aparty.

How

ever,In

tineM

atterof

BC

CI

(Overseas)

Ltd.

inL

iquid

atio

nt5t

where

theapplicant

bankw

asactually

aparty

toproceedings

inE

ngland,it

was

permitted

(throughits

liquidator)to

discloseinform

ationpursuant

toth

isex

ceptio

n.

Thirdly,

disclosurem

aybe

made

where

tinerelevant

professionalperson

doesso

with

theapproval

ofthe

Financtal

Secretary

andit

isnecessary

forthe

protectionof

himself

orany

otherperson

againstcrim

e.Finally,

disclosureis

allowed

where

this

isdone

inaccordance

with

anyother

law

.’33

This

important

gateway

would

includethe

provisionsin

theanti-m

oneylaundering

laws,

forreporting

suspicionsof

money

laun

dertng,and

byvirtue

ofw

hichthe

personm

akingthe

disclosureis

specifically

exempted

fromliability

forviolating

theconfidentiality

prohibitions, t54A

sa

general

rule,a

personw

hois

requiredto

giveevidence

beforeany

proceedings(either

within

oroutside

Caym

an)in

connectionw

ithconfidential

information

must

firstobtain

the

directionsof

thecourt

fora

determination

ofw

hetherit

isperm

issiblefor

himto

do

so.

t35

Essentially

thecourt

will

make

adeterm

inationas

tow

hetherthe

purported

disclosurefalls

within

oneof

thestatutory

excep

tions.’

36

litR

eHt5

7the

applicant

trusteesought

directionsas

tow

hetherhe

shouldcom

plyw

itha

subpoenaserved

in

Pennsylvania

requiringhtm

totestifi

beforea

grandjury

there.It

was

deemed

tobe

aproper

andnecessary

application,since

underC

ayman

law,

without

theproper

consentof

theappropriate

principal,the

applicantis

obligedto

seekthe

court’sdirec

tionsand

abideby

theoutcom

e.

Ingeneral,

wherever

confidentialityobligations

exist,they

may

bew

aivedby

the

consentof

thebeneficiary

ofthe

confidence,as

longas

suchw

aiveris

voluntaryand

notcom

pelled.in

theM

atterofA

BC

Ltd.lSt

itw

asheld

thata

consentform

signedin

compliance

with

theorder

ofa

foreigncourt

isnot

trueconsent

atall,

sinceit

isnot

givenfreely

andin

theexercise

ofan

independentand

uncoercedjudgm

ent.T

hatis,

it

amounts

merely

tosubm

issionto

forc

e)

9T

hisw

asreaffirm

edin

Re

Hw

herethe

courtw

astold

thatthe

beneficiaryof

theconfidence

didnot

objectto

thedivulging

of

theinform

ationby

thesubpoenaed

applicant.N

evertheless,the

courtfound

thatthat

is

notto

betaken

anauthorisation

within

them

eaningof

theC

RP

L,

sincethat

person

isalso

anA

merican

cttizenand

isthe

subjectof

thegrand

jury’sinvestigations.

t1992’-31C

.LL

.R.

131.‘,

tt994—3l

C.5.L

.R.

56.152

n.3(2)(b)(vi)

CR

PL.

s.3(2)(c)

CR

PL.

154F

oreaam

ple,o.

23(5).P

roceedsof

Crim

tnalC

ondactL

aw1(2001

Rev.)

providesa

defenceto

acharge

ofacquiring

anotherperson’s

proceedsof

criminal

coudsct,fo

raperson

who

made

priordisclosure

ot

hisknow

ledgeor

snspscion.T

hatperson

would

notbe

deemed

tohave

violatedany

restrictionon

the

disclosureof

information.

55S.4

CR

PL.

56per

t4nrre3

Re

BC

CI

(Overseas)

Ltd.op.

cit.IS?

[1996JC

.J.L.R

.238.

[1984]C

.1.L.R

.130.

159T

heIssne

ofcom

pelledw

aiverof

consentw

iltbe

examined

inC

hapter9.

5051

Money

Laundering

Control

inthe

fJaribbeanO

ffshoreF

inancialH

avensand

Money

Laundering

Consequently,

itw

asregarded

assettled

lawthat

evenan

expressedC

onsent,let

alone

acquiescenceor

non-objection,if

givenunder

painof

penalty,m

aynot

beaccepted

by

theC

ayman

courtsas

validconsent

orauthorisation.

Where

theperson

requiredto

make

disclosurein

theforeign

proceedingshas

not

obtainedthe

requisiteperm

ission,he

may

seekto

refusedisclosure

onthe

basisthat

histestim

onyw

ouldexpose

himto

criminal

liabilityin

theoffshore

jurisdiction.In

Drannigan

v.D

aviso

nt6°

theplaintiffs

refusedto

testifyin

aninquiry

inN

ewZ

ealand

onthe

groundthat

todo

sow

ouldresult

intheir

comm

ittingcrim

inaloffences,

contrary

toC

ookIslands

secrecylegislation,

andthat

theyshould

besllow

edto

raisethe

privilegeagainst

self-incrimination.

How

ever,it

was

heldby

thePrivy

Council

thatthe

privilegeagainst

self-incrimination

doesnot

obtainw

herethe

criminal

orpenal

sanc

tionsarise

undera

foreignlaw

.T

hereasoning

oftheir

Lordships

isthat

ifthe

privilegew

ereapplicable

itw

ouldhave

theeffect

ofaccording

primacy

toforeign

law,

sinceit

would

overridethe

domestic

court’sability

toconduct

itsproceedings

in

accordancew

ithits

own

lawand

procedures.A

sthe

PrivyC

ounciladvised,

different

countrieshave

theirow

ninterests

topursue.

Acontrary

conclusionw

ouldgive

the

witness

anabsolute

responseto

refuseto

answer

thequestion

whatever

thenature

of

theactivity

proscribedby

theforeign

law,

andhow

everim

portantthat

answer

might

be

forthe

purposesof

thedom

esticcourt’s

pro

ceedin

gs)

6t

CoN

cLusio

N

moved.

Inthese

cases,it

isclear

thatoffshore

havensrem

aina

formidable

hurdlein

controllingm

oneylaundering.

The

challengefor

offshorejurisdictions

isto

findthe

delicatebalance

between

remaining

competitive

asan

offshorecentre

andpreventing

theirfinancial

servicesfrom

beingexploited

forillicit

purposes.W

ithless

confidentialityand

more

controlof

theplayers

inthe

offshoresector,

aw

orkableequilibrium

couldbe

achieved.O

therwise,

anyw

rong-footingcould

leadto

acentre

gainingnotoriety,

andperpetuate

itsstatus

asa

safehaven

forthe

proceedsof

criminal

activities.For

fartoo

longC

aribbeanoffshore

centreshave

fallenprey

tothe

misdeeds

ofcrim

inalsfrom

aroundthe

world,

andalthough

some

attempt

isnow

beingm

adeto

reversethis

downw

ardspiral,

itw

illtake

more

time

anda

greatdeal

more

regulationbefore

theycan

shedthis

iniquitousim

age.P

erhapsthen,

theprophesy

will

befulfilled

andparadise

regained.

Offshore

havenshave

beenlabelled

ascentres

forgiving

explicitlycrim

inalactivity

aprotective

shield“by

thoseintent

ondefending

them

achineryof

peekaboofinance

fromthe

probingeyes

anditchy

fingersof

thejudicial,

fiscaland

monetary

auth

ori

ties”of

othercountrie

s.162

The

offshorefinancial

industryin

theC

aribbeanw

as

conceivedto

improve

theeconom

iesof

thoseterritories

andnot

intendedto

entice

criminals

orencourage

money

laundering.It

was

designedand,

toa

largeextent,

has

succeededin

producingbenefits

forthe

localeconom

y,including

generatingrevenue

fromlicense

fees,increasing

capitalinflow

sand

developingthe

financialand

legal

servicesse

cto

rs.t63

How

ever,inadequate

controlshave

ledto

thesehavens

being

blamed

forserving

asthe

‘cleansingagent’

fordirty

morley,

andfor

permitting

the

proliferationof

taxevasion

andother

white

collarcrim

es.

High-profile

incidentssuch

asthose

discussedin

thischapter

will

continueto

keep

thespotlight

shiningbrightly

onoffshore

financialcentres,

andreinforce

thestigm

aof

delinquency.A

sw

illbe

discussedlater,

effortsare

beingm

adeto

controlthe

abuseof

theoffshore

financialsector,

includingthe

dilutionof

them

uch-maligned

confiden

tialitylaw

s.H

owever,

much

remains

tobe

done,as

thedegree

ofsuccess

incracking

am

oneylaundering

caseis

stillvery

dependenton

beingable

tobreak

down

eachlevel

ofsecrecy

attainedby

thelaunderer.

The

money

laundererw

ishingto

spinan

ever

more

tangledw

ebcould

invokea

combination

ofthe

offshorebank,

trustand

company

regimes.

Foran

investigatorto

destroythe

confidentialitybarriers

ateach

layerw

ould

requirem

onthsor

years,w

hena

fewhours

isall

hem

ayhave

beforethe

fundsare

601)9971

AC

.238

This

approachw

asalso

takenin

Austraha

inB

ankof

Valena

plcn

National

Crim

e

Asshority

[1999]F.C

.A.

1099.61

Brannigan

eD

avisonat

245—9.

62R

.T.N

aylor,H

ot Money

andthe

Politics

ofD

ebt(1994).

63s•

Young

Chang,

The

Econom

icIm

pactof

Offshore

Banking

Centers

onthe

Host

Countries”

in

Y.S.

Parkand

1sTE

ssayyad(edt.),

InlernaiionalB

ankingand

Financial

Centers

(1959).

5253

University of Miami Inter-American Law Review

Fall 2008

THUNDER IN PARADISE: THE INTERPLAY OF BROADENING UNITED STATES ANTI-MONEY LAUNDERING

LEGISLATION AND JURISPRUDENCE WITH THE CARIBBEAN LAW GOVERNING OFFSHORE ASSET

PRESERVATION TRUSTS

Evan Metaxatos [FNa11

*170 I. Introduction

Traditional notions of ‘offshore accounts’ bring to mind images of large sums of money gained through

illegitimate means and purposefully concealed from the view of United States authorities, or earned

legitimately but shielded from otherwise applicable taxes by means of its location in an offshore

account. While there may be some historical basis for this assumption, the modern offshore asset

preservation trust is far removed from such preconceived notions and much more nuanced.

Over $5 trillion dollars is invested in banks, mutual funds and trusts located across the world’s 35

international offshore financial centers FN11 and many law-abiding customers are increasingly placing

their money in what have simultaneously been called offshore asset preservation trusts, asset

protection trusts, or self-settled trusts. [FN2] In reality, asset preservation trusts offer few tax

advantages; [FN31 their primary benefit is instead derived from the privacy they provide their

beneficiaries and settlors, their flexibility, and their ability to withstand the jurisdictional furor of foreign

judgments. IFN41

Offshore asset preservation trusts have come under attack in recent years, however, by both U.S.

legislators and courts frustrated in their attempts to enforce judgments in foreign jurisdictions. Much of

this pressure is the result of the frequent use of asset preservation trusts in concealing and shielding

assets derived from fraudulent schemes and money laundering associated with the illegal drug trade.

[FN5] An increasing amount of pressure, however, is being directed towards these trusts due to their

use in more legally ambiguous activities such as protection of assets from foreign civil judgments. [FN61

Attacks on asset preservation trusts have come in the form of an increasingly broadening view of the

reach of American jurisdiction, the enactment of new legislation for the purpose of combating the

money laundering, and *171 international cooperation with offshore jurisdictions. LFN7I

This article will first discuss the general benefits to be derived from the management of both legitimate

and illegitimate offshore asset preservation trusts, and whether some of the more ambiguous features

of such trusts lead to the conclusion that they are fraudulent on a de facto basis. It will then address the

steps the United States has taken recently, both legislatively and judicially, to reach the assets in these

trusts, and some of the international cooperative efforts undertaken to combat the illegitimate ways in

which people have used offshore asset preservation trusts. This article will next focus on the myriad of

responses to U.S. pressure by various offshore Caribbean jurisdictions, with special focus on the

7

Bahamas and the Cayman Islands. Lastly, the article will address whether American laws have overreached in their attempt to combat money laundering, the sufficiency of the Caribbean response toAmerican pressure, and what the drafter of an asset preservation trust should keep in mind whenforming and managing a ‘legitimate’ offshore asset preservation trust.

II. The Benefits of Establishing an Offshore Asset Preservation Trust

It is no coincidence that the rising popularity of offshore asset preservation trusts in recent years hasparalleled the sharp rise of litigation in the United States. [FN81 As an increasingly large segment of thepopulation has found themselves subject to liability by U.S. courts, they have sought to protectthemselves from potential creditors by placing their assets beyond the reach of a court’s jurisdiction.Once reserved for the ultra-wealthy, asset preservation trusts can now be opened over the internet inorder to shield doctors from malpractice suits or insulate assets in dispute during a divorce proceeding.[FN9] While both domestic and foreign asset protection trusts may be able to provide a base level ofprotection against U.S. creditors, foreign trusts provide additional benefits because of their geographicallocation, divergence from certain *172 common law forced heirship laws, the ability for a trust to be“self-settled,” and immunity from foreign judgments.

Both the role asset preservations trusts play in avoiding foreign judgments and the legally tenuousmeans by which they accomplish their role have lead some critics to conclude that such trusts arefraudulent devices by their very nature. [FN1O] Others argue, however, that as punitive damage awardsin the United States continue to increase, people are justified in moving their assets to offshorejurisdictions where such unreasonable awards are less likely to be awarded, and that U.S. courts shouldrespect the laws and sovereignty of these foreign jurisdictions. FN111

A. Tax Benefits

Contrary to popular belief, harboring money in an asset preservation trust does not immunize either thesettlor or the beneficiary of the funds from tax liability in their home country. Although the settlor ofsuch trusts typically does not have to pay taxes in the offshore jurisdiction where the trust is located, thesettlor is still liable for any taxes in their home jurisdiction where the assets were initially procured.[FN12] Avoidance of taxes is therefore not an important factor contributing to the decision of a settlorto go offshore. [FN13} The benefits of such trusts have instead been characterized by the degree ofcontrol they afford their settlors, their protection by strict banking confidentiality laws, and theimmunity they enjoy from foreign judgments.

B. Self-Settled Trusts

The defining characteristic of an offshore asset preservation trust is its allowance of the settlor to retain

control over both the management of the trust and its ultimate retention. [FN141 The very *173 idea of

a self-settled trust [FN151 seems paradoxical to people who view a trust as an instrument in which the

settlor relinquishes control of his assets. [FN161 Typically a settlor must still show caution in the amount

of control he exerts over trusts. [FN171 As offshore legislation expands such power, however, a settlor

increasingly has more latitude to govern the disposition of his assets. For instance, under Cayman Island

trust legislation, a settlor can revoke, vary, or amend the trust instrument; instruct a trustee regarding

how the funds should be invested; change the forum law by which the trust is governed; and reserve for

himself a beneficial interest in the trust. [FN181 Engaging in such activities with an ordinary trust would

typically lead to the trust being considered a sham, [FN191 but this is much more difficult when these

powers are statutorily authorized. As a result of such power, it can be nearly impossible for a Caribbean

court to conclude that an asset preservation trust is a sham which would render it vulnerable to foreign

judgments. [FN2O1

C. Strict Banking Secrecy Laws

People also flock to offshore asset preservation trusts in order to reap the benefits of their unrivaled

banking secrecy laws. IFN21] While some people may use offshore trusts in order to conceal illicit funds

from the eyes of U.S. investigators, others do it because they fear ‘Big Brother’ or simply wish to keep

their affairs private. [FN221 For instance, an offshore jurisdiction will typically not force production of

confidential information unless the debtor has *174 committed a crime in their home jurisdiction which

is also a crime in the offshore jurisdiction. [FN23] Because many offshore jurisdictions also have no

income or estate taxes, there are no comparable tax crimes by which the debtor can be held liable for

and therefore forced to comply with a subpoena. [FN24]

It should be noted, however, that no jurisdictionsTconfidentiality laws can be said to be absolute and

some offshore jurisdictions do divulge information in limited circumstances. In the Bahamas, for

instance, a court will grant a U.S. court order requiring the disclosure by a bank or trust company of

confidential information in some circumstances, so long as the subpoena duces tecum is limited in scope

and specific. [FN251 In the Cayman Islands, disclosure of confidential information is allowed when done

in accordance with any other law of the Cayman Islands. [FN261 Although the circumstances in which an

offshore jurisdiction will comply with a U.S. court order are still substantially limited, such circumstances

are broadening as a result of U.S. pressure to combat money laundering.

D. Circumventing Forced Heirship Laws

Another benefit derived from offshore asset preservation trusts is their avoidance of common law rules

regarding forced heirship. When the owner of a property in a U.S. jurisdiction typically wishes to convey

his or her interest in a property to another, forced heirship, marital property, and other laws may

interfere with how the owner of the property wishes it to be distributed. fFN27] For instance, many

states still enforce a rule against perpetuities, [FN2S1 which restrains the long-term distribution of

5o

property. If the property is held in an offshore asset preservation trust, however,*175 such laws are of

no consequence. In addition to abolishing the rule against perpetuities, [FN291 most foreign jurisdictions

have also abolished forced heirship laws and spousal right laws. [FN3O1 The flexibility of offshore asset

preservation trusts therefore allows the owner of property to have more control over who ultimately

receives his property and allows a property owner to maintain this control for longer periods of time.

E. Immunity From Foreign Judgments

Perhaps the most important feature of an offshore asset preservation trust in the eyes of a settlor is its

seeming invincibility from judgments rendered in foreign jurisdictions. This invincibility results from

simple obstacles, such as the geographic distance between the United States and these foreign

jurisdictions, as well as very complex jurisdictional issues arising from the independent judicial systems

these countries enjoy that are free to disregard the orders of U.S. courts.

Once a judgment for damages is entered against a criminal or civil defendant by a U.S. court, the

prevailing party will typically wish to have this judgment enforced. If the assets are in the United States,

this is a simple process in which the deciding court simply issues a court order, which all U.S. financial

institutions are required to comply with, to turn over the assets. [FN31] Foreign institutions, however,

are under no obligation to comply with a court order from the United States. Courts must therefore

either have their judgments recognized by the foreign jurisdiction, or exert pressure on the settlor to

comply with their court orders. [FN32]

1. Settlor Under Pressure

When U.S. courts attempt to exert pressure on a settlor, a number of unique issues arise. In an asset

preservation trust the settlor is typically also the beneficiary. fFN331 This might lead one to the

conclusion that when the settlor owes money, withdrawing the needed money from an asset

preservation trust is well within the *176 purpose for which the trust was created. [FN341 The primary

purpose of an asset preservation trust, however, is to protect against foreign judgments. [FN351 Because

withdrawing money in order to pay off a foreign judgment runs afoul of the main purpose for such

trusts, foreign financial institutions have typically argued that actions by the settlor in furtherance of this

goal should not be complied with, and Caribbean courts have agreed. For instance, the Cayman Islands

have refused to recognize a receiver of an offshore trust appointed by a U.S. court, [FN361 and have

likewise refused to recognize consent forms signed in compliance with an order of a foreign court.

[FN371

Several additional features unique to offshore asset preservation trusts also help to alleviate pressure

on the settlor that follows a judgment of liability in a U.S. court. First, their usual inclusion of a ‘flee

clause’ permits the settlbr to change the situs [FN3S1 of the trust to a more favorable jurisdiction if it

seems that the trust may come under legal attack. [FN39] Therefore, while a settlor may initially

maintain a trust in a jurisdiction which affords preferential treatment in the management of the trust, if

litigation is imminent, the settlor can change the situs of a trust to an alternate jurisdiction which will

minimize a creditor’s ability to enforce a judgment against the trust. [FN4O1 By including a ‘flee clause’ in

an offshore asset preservation trust, not only are creditors discouraged from bringing suit, but if they

are prepared to bring suit they may initially over-commit resources in a jurisdiction which will ultimately

not litigate the issue.

Most often, however, the decision to move the situs of a trust pursuant to a ‘flee clause’ is not made by

the trustee, but is *177 instead made by the ‘protector’ [FN411 of the trust, another benefit unique to

offshore asset preservation trusts. If a protector feels that the trustee is acting under the duress of a

foreign jurisdiction, it is typically within his authority to remove the trustee; invoke a ‘flee clause’ in

order to move the trust to another situs; and freeze benefits payable to beneficiaries. [FN421 These

illustrations make it clear that attempts by a U.S. court to exert pressure of a settlor in order to seize

assets are typically met by a number of unique obstacles if the funds are located in an offshore asset

preservation trust.

2. Enforcement of Foreign Judgments

If exerting pressure on a settlor/beneficiary in the United States is unsuccessful, an American court will

typically seek to have its judgment enforced in the jurisdiction where the assets are located. In order for

a court’s judgment to be enforced, however, it must first be recognized. [FN43] In the United States, a

court will typically recognize the judgment of a foreign court as a matter of comity, 1FN441 so long as the

foreign court is able to impartially administer justice. I FN4S] This does not mean, however, that foreign

jurisdictions will reciprocate this comity in recognizing the judgments of U.S. courts. When foreign

countries do not automatically recognize the judgment of a U.S. court as a matter of comity, such

countries may also enter into both bilateral and multilateral treaties with the United States in order to

have their judgments enforced. [FN461 As this article will discuss, U.S. pressure has compelled various

Caribbean jurisdictions to enter into such agreements to enforce foreign judgments, but only in limited

circumstances. In other circumstances, Caribbean courts still fail to recognize the judgments of American

Courts and creditors are typically required to argue the case anew in a foreign jurisdiction.

F. Benefits to Caribbean Countries of Harboring Asset Preservation Trusts

Although the benefits of an offshore asset preservation trust for a settlor are clear, such trusts also

benefit the jurisdictions in which they are harbored. Many of the Caribbean jurisdictions which house

these trusts are still emerging economies, attempting to shift from systems based on agriculture to

economies based on tourism and financial services. [FN5O1 In accomplishing this transformation, the

subtle nuances of their trust legislation can sometimes be a double-edged sword, simultaneously

attracting foreign investors with their lax regulations and jurisdictional independence, and frustrating

foreign governments because of their failure to cooperate with judgments aimed at assets harbored

abroad. Foreign governments such as the United States, however, are not without their means of

persuasion, and it has been the task of Caribbean governments to strike a proper balance regarding

their trust legislation.

*179 III. The United States Response to the Problem of Money Laundering

The ability of offshore asset preservation trusts to withstand the enforcement of foreign judgments has

led to their increasing popularity for both legally ambiguous uses such as shielding assets from divorce

proceedings and the avoidance of what might be considered excessive punitive damages awards, [FN51]

to outright illegal uses such as the laundering of money associated with the illegal drug trade. 1FN521

The United States has therefore sought to lift the veil of secrecy surrounding offshore asset preservation

trusts and attack the protections these trusts provide their settlors. The United States first took aim at

the problem of money laundering.

Money laundering was not even addressed as a problem in the United States until 1970 1FN531 and was

not made a crime until 1986 when Congress enacted the Money Laundering Control Act. [FN54] The

Money Laundering Control Act made it a crime to launder the proceeds of criminal activity by engaging

in financial transactions, with either the intent to promote that criminal activity, to conceal the origins of

the profit, or avoid reporting requirements on the money. [FN55] Although early anti-money laundering

legislation was drafted with the problem of illicit drug trafficking in mind, the scope of what courts are

willing to consider “financial transactions” for purposes of identifying money laundering has expanded in

recent years to include other transgressions as well. [FN561 As financial institutions have come under

increasing pressure to divulge information regarding the origins of money suspected to be gained

through illegal activities, money laundering has moved offshore where such laws are not applicable.

A. The Jurisdictional Reach of U.S. Anti-Money Laundering Laws

The attempts of U.S. investigators to pursue money launderers offshore have been met with a number

of obstacles, however, that have required both bold new legislation and judicial ingenuity* 180 to

overcome. The most obvious problem facing investigators is jurisdictional in nature. How can a U.S.

court enforce a judgment, subpoena, or court order against a person or financial institution located in

another sovereign country? As mentioned earlier, in order to enforce a judgment, a court must either

compel the settlor or financial institution to voluntarily comply with the court order, or persuade the

Caribbean jurisdiction to recognize the judgment of the U.S. court. [FN571

Where either the settlor or the financial institution managing the trust has a presence in the United

States, courts have often relied on exerting pressure. While the protections afforded to the settlor of an

asset preservation trust have been discussed, these protections do not necessarily extend to the

financial institutions which act as trustees. For instance, many courts will hold the U.S. subsidiary of a

financial institution [FN58j liable for the refusal of their branch in a foreign jurisdiction to comply with a

court order. [FN591 The financial institution is therefore faced with the unappealing dilemma of either

complying with a U.S. court order regarding the disposition of a foreign trust, or violating the trust laws

of where the trust is located, If the financial institution has a significant presence in the United States

then the scales may tip in favor of complying with a U.S. court order because the financial institution

may have more to lose.

But what happens when there is no domestic branch of a financial institution to hold responsible and

the structure of an asset preservation trusts nullifies any pressure a court can exert over a settlor? The

U.S. court must then seek to have its judgment enforced by a Caribbean court. As mentioned earlier,

however, in order for a court’s judgment to be enforced, it must first be recognized. Because most

Caribbean jurisdictions do not recognize U.S. judgments as a matter of comity, enforcement of U.S.

judgments takes place under a patchwork of treaties that provide incomplete coverage.

*181 1. Extraterritoriality

It should also be noted that U.S. courts have engaged in an extraterritorial [FN6O] expansion of

prescriptive and enforcement jurisdiction as well. [FN611 American courts have claimed the right to

extraterritoriality when either a significant part of the illegal conduct in question takes place in the

United States or the illegal activity takes place outside U.S. borders but has consequences within the

United States. [FN62] In the first instance, varying U.S. courts have taken differing stances regarding just

how much “conduct” has to take place within the United States in order to subject a foreign person or

entity to the laws of the U.S. . For instance, Judge Friendly, writing for the Second Circuit, has held that

prescriptive jurisdiction can be based on the “perpetration of fraudulent acts themselves but does not

extend to mere preparatory activities or the failure to prevent fraudulent acts where the bulk of the

activity was performed in foreign countries.” [FN63] In other words, Friendly takes a somewhat limited

view regarding the amount of conduct that might expose a foreign entity to U.S. jurisdiction.

Other scholars, however, now express concern that the United States has embarked on a bold expansion

of extraterritoriality and can now assert prescriptive and enforcement jurisdiction against a financial

institution anywhere in the world simply because the institution has executed trades in U.S. currency

which have to be booked in corresponding U.S. banks. [FN64] Most banks around the world trade to

some extent in U.S. currency, however, and such a rule would bring many transactions under the

jurisdiction of U.S. courts which would otherwise be excluded. 1FN651 Such an interpretation of

“conduct” is therefore dangerously broad in its assertion of extraterritorial jurisdiction and runs the

danger of infringing upon the sovereignty of other nations. Nevertheless, Courts are beginning to

expand their rule *182 of what sort of conduct is enough to bring financial activities under the purview

of U.S. courts and this trend is expected to continue. [FN66]

U.S. courts have also been willing to exert prescriptive jurisdiction over foreign entities even when their

illegal conduct takes place outside of the United States, so long as the conduct creates a substantial

adverse effect in the United States. [FN67] Under this doctrine, a company does not even need to have a

presence in the United States or engage in conduct within U.S. borders to fall under U.S. prescriptive

jurisdiction. 1FN681 While the “substantial effect” test is indeed an effective way of targeting the

perpetrators of fraudulent international investment schemes aimed at U.S. investors, it also raises

questions of the limits of U.S. laws and the dangers of asserting extraterritorial jurisdiction.

When the “conduct” and “substantial effect” tests are taken in conjunction with the pressure the United

States already exerts on settlors and financial institutions, the U.S. approach to money laundering

evinces a broad assertion of extraterritoriality. The PATRIOT Act, however, has even further broadened

the reach of U.S. jurisdiction.

2. The USA PATRIOT Act

Although prior to September 11, 2001, attempts to expand the reporting requirements of financialinstitutions were met with widespread opposition and concerns about invasion of privacy, [FN69} theturmoil surrounding the worst terrorist attack in our nations history allowed the PATRIOT Act to passwith sparse opposition. [FN7O1 Under the guise of fighting terrorism, the PATRIOT Act hassignificantly*183 expanded the definition of what constitutes a financial institution for purposes ofcombating money laundering [FN71] and has conferred on district courts ‘long-arm’ jurisdiction [FN721over foreign persons and financial institutions. [FN73j Specifically, this is accomplished through Title Illof the PATRIOT Act, the International Money Laundering Abatement and Financial Anti-Terrorism Act of2001 [FN741 that amends both the 1970 Bank Secrecy Act and the 1986 Anti-Money Laundering Act.[FN75]

For instance, the PATRIOT Act enables the Secretary of the Treasury to issue a summons or subpoena to“any foreign bank that maintains a correspondent account in the United States and request recordsrelated to such correspondent account, including records maintained outside the United States relatingto the deposit of funds into the foreign bank.” {FN761 Although such subpoenas were generally issuedunder 18 U.S.C.A. § 1956(a) before the passage of the PATRIOT Act, when compliance with thesubpoena or summons ran afoul of foreign laws governing confidentiality, the U.S. court, for reasons ofcomity, would typically defer to the foreign court. [FN771 Now, however, U.S. courts will press forwardand financial institutions will be required to submit to the jurisdiction which can exert the most pressureon the financial institution to comply with their laws. [FN781

Financial institutions are also now required to maintain “records of the information used to verify aperson’s identity, including name, address, and other identifying information.” [FN79] While suchinformation may seem trivial in nature, it helps U.S. investigators in tracking the source of funds in orderto combat money laundering. For purposes of asset preservation trusts, this information also becomesproof that a debtor has funds in an offshore account. Financial institutions are now also more willing toprovide this information to investigators because § 351 of the PATRIOT Act amends the Bank Secrecy Act(1970) by providing *184 financial institutions with legal immunity from liability for voluntary disclosuresof suspicious transactions. IFN8O1

B. Broadening Judicial Interpretation of Anti-Money Laundering Laws

The enactment of new legislation combating money laundering has also been accompanied bybroadening judicial interpretation of these statutes. Money laundering was initially outlawed in 1986 tocombat the illicit drug trade. [FN81] Since then, however, courts have interpreted 18 U.S.C.A. § 1956 toencompass concealing the “proceeds” of bankruptcy fraud in offshore accounts as well. [FN821 As aresult of this interpretation, § 1956 is now made applicable to a much broader number of assetpreservation trusts. Other courts have also expanded the definition of “intent” under § 1956 to include“willful blindness.” [FN83} Under such an interpretation, a lawyer who establishes such a trust is nowunder a duty to investigate the origins of money deposited therein in order to ensure that the moneywas gained through legitimate means.

U.S. court decisions have also methodically targeted many of the specific aspects of offshore asset

preservation trusts which make them desirable to customers. For instance, in United States v. Bank of

Nova Scotia, [FN84} a landmark case, the 11th Circuit held that the interest of American citizens in the

privacy of their bank records located offshore was substantially reduced when balanced with the

interest of their own government in a criminal investigation. [FN851 As a result of this decision, banks

can now look at the relative interests of the different states involved in order to come to the conclusion

that America’s interest in pursuing a criminal investigation may outweigh any comparable interest a

foreign state might have in enforcing bank secrecy laws. [FN861

U.S. courts have also turned up the heat on the settlor of the trust in order to collect more information

regarding the trusts or *185 attach the assets. Courts have held that a settlor can be held in contempt of

court and incarcerated for failing to cooperate with a court order to turn over records regarding the

trust. [FN871 While a settlor can typically claim that they have no power to comply with such an order to

produce bank records, [FN88] in an offshore asset preservation trust such a claim is more tenuous

because the settlor retains substantial power over the trust.

In Eulich v. United States, [FN89] for instance, the district court did not buy the argument that the

settlor had no control over his trust when the IRS demanded documents relating to it. The court ordered

Eulich to produce documents concerning the trust by all means possible, including filing a lawsuit in the

Bahamas to facilitate production of the documents. FFN9O] In Eulich, the court found that to the extent

that producing the documents was impossible for Eulich, it was only because of the situation which

Eulich himself created by depositing between $75-$100 million dollars in a Bahamian asset preservation

trust, and that Eulich should not be allowed to benefit from the situation he had created. [FN911

In addition to attacking some of the specific features of offshore asset preservation trusts, U.S. courts

have also expanded the scope of what sort of trusts they are willing to consider illegitimate. In

Breitenstine v. Breitenstine, [FN921 the Wyoming Supreme Court evaluated a Bahamian asset

preservation trust used by a husband to shield assets from his wife before an impending divorce

proceeding. The Court concluded that such a use was “reprehensible” and that the asset preservation

trust was created to hinder, delay, or defraud the husband’s creditors. FFN931

Such legally ambiguous uses raise broad public policy questions concerning offshore asset preservation

trusts and lead some to conclude that such trusts are fraudulent on their face. [FN941 Others argue,

however, that they are merely another form of trust which *186 affords the settlor more control, [FN95]

a feature that is not in itself fraudulent. However one views such accounts, the United States has led the

way in pressuring offshore jurisdictions to adopt more lenient bank secrecy laws, but they have also

employed the help of others along the way.

C. The International Fight Against Money Laundering

Of course, the United States is not alone in its attempt to stem the flow of illicit money into offshore

jurisdictions. With America leading the way, the United Nations has formed the International

Convention for the Suppression of the Financing of Terrorism, which recognizes the need for

cooperation among States in devising and adopting effective measures for the prevention of the

financing of terrorism. [FN96j The Convention calls upon its signatory countries to take steps to prevent

and counteract the financing of terrorism through appropriate domestic measures as well as through

international cooperation. [FN97] While an effective means of fighting money laundering in theory,

certain key offshore jurisdictions, including the Bahamas, have not yet ratified the treaty. [FN981

The G7, led by the United States, has also undertaken the task of combating money laundering. In 1989

the G7 formed the Financial Action Task Force (hereinafter “FATF”) in order to recommend measures to

improve countriesTmoney laundering laws. [FN991 The FATF issued forty recommendations [FN1001 thatprovide a guide to countries in revising their legislation. In 2000, FATF issued a report in which itidentified “serious systematic problems” with the anti-money laundering laws of five Caribbean nationsincluding*187 the Bahamas and Cayman Islands. [FN1O1] Although the FATF’s power to enforce these

recommendations relies on engaging in dialogue with non-compliant nations and the embarrassment

associated with being non-compliant, [FN1O21 the method seems to have worked because Myanmar,

the last country to be listed as non-compliant by the FATF, has been removed from the list. [FN1O3] How

effective these forty recommendations are at curtailing either the legitimate or illegitimate usage of

offshore asset preservation trusts remains to be seen. [FN1O41

IV. The Caribbean Reaction

Various Caribbean jurisdictions have responded to international and unilateral U.S. pressure to fight

money laundering through a number of legislative enactments and judicial opinions. While some

legislative enactments have been viewed as positive steps forward, others have had a limited effect on

the operation of asset preservation trusts. In like manner, various Caribbean judiciaries have issued

decisions both in an attempt to cooperate with efforts to fight money laundering and in defense of their

own sovereignty.

A. Caribbean Legislative Response

The Caribbean legislative response to U.S. pressure to address money laundering has differed from

country to country, but certain trends have become apparent. These trends include the erosion of

banking secrecy laws and the formulation of financial intelligence units to facilitate international

cooperation, but the overall preservation of the asset preservation trust’s immunity from foreign

judgments.

In the Cayman Islands, for instance, the legislative assembly has signed a ‘Statement Regarding Drug

Cooperation’ [FN1O51 in *188 response to Bank of Nova Scotia [FN1O61 and a subsequent ‘exchange of

letters’ among the United States, the Cayman Islands and United Kingdom. [FN1O71 This agreement

allows for Caymanian courts to compel production of bank documents in specified drug cases. [FN1O8]

The agreement, however, is not made applicable to cases of either tax evasion (which is not a crime in

the Cayman Islands because there are no income taxes) or when a debtor is attempting to shield assets

from a creditor. 1FN1091 As a result, many of the uses of the asset preservation trust in the Cayman

Islands remain unaltered and creditors wishing to attack some of these more legally tenuous uses of

asset preservation trusts have been required to try the case anew in the Cayman Islands.

The Cayman Islands has also formed the Cayman Island Monetary Authority, which is charged with

implementing the country’s anti-money laundering laws and providing assistance to overseas regulatory

authorities. FFN11Q1 The primary money laundering legislation the Monetary Authority is charged with

upholding is the Proceeds of Criminal Conduct Law (2007 Revision), [FN1111 which covers all businesses

and individuals. Like the Statement Regarding Drug Cooperation, however, the Proceeds of Criminal

Conduct Law is limited in scope and only made applicable to “criminal conduct,” which is defined as an

indictable offense if it had occurred in the Cayman Islands or conduct committed outside the jurisdiction

that would constitute an offense if it had been committed within the Cayman Islands. [FN112I The scope

of the Monetary Authority therefore does not encompass U.S. laws unless those laws are also laws of

the Cayman Islands.

Similar to the Cayman Islands’ Monetary Authority, the Bahamas created the Financial Intelligence Unit

in 2000 pursuant to the Financial Intelligence Unit Act 2000 [FN1131 in response to *189 being

blacklisted by the Financial Action Task Force. Also like the Cayman Island Monetary Authority, the

Bahamas Financial Intelligence Unit is mandated by law to cooperate with international law

enforcement agencies in order to stem the flow of money laundering [FN114I and as a result has won

removal from the list of countries regarded as noncompliant with the Financial Action Task Force’s list of

forty recommendations. [FN1151 Although the Bahamas have no tax treaties in force, their Financial

Intelligence Unit has also entered into mutual legal assistance treaties with other nations which provide

for the exchange of information and compliance with specific foreign court orders. [FN1161 In the

calendar year 2006, the Financial Intelligence Unit received sixty-six requests for assistance from foreign

financial investigatory units, eleven of which were from the United States, and was able to provide

assistance or is providing assistance ninety-one percent of the time. [FN117] These steps mark a positive

step forward in the fight to combat illegal money laundering without interrupting the operation of

legitimate offshore asset preservation trusts.

Not all recent laws, however, are being adopted for the purpose of making it easier for foreign courts to

enforce judgments against assets in a foreign jurisdiction, It is relatively recently, for instance, that the

Bahamas have enacted a two-year statute of limitations on the commencement of proceedings alleging

a fraudulent conveyance into a trust [FN118I and have placed the burden of establishing the settlor’s

fraudulent intent on the creditor seeking to set aside the transfer. [FN119] Since the ordinary course of

litigation in the United States often takes years to begin with, many creditors*190 may find that by the

time they realize the assets they seek are in a Bahamian asset preservation trust, it is too late to file suit

in the Bahamas.

The laws in St. Christopher and Nevis in like manner have established a very high burden for establishing

a fraudulent conveyance into a trust. The recently enacted ‘Proceeds of Crime Act’ [FN12O1 stipulates

that, “It shall be a defense to a charge under this section if the person satisfies the Court that he did notknow or had no reasonable grounds for knowing that the property referred to in the charge wasderived, directly or indirectly, from some form of serious offence.” [FN121] Nevis therefore takes amuch stricter view of what constitutes a fraudulent conveyance than do most U.S. courts. For instance,the Eighth Circuit in Oberhauser held willful ignorance was enough to establish intent for purposes ofproving a fraudulent conveyance. FFN122I Therefore, while a U.S. court may establish a fraudulentconveyance upon a finding of willful ignorance and exert pressure on the settlor, a court in Nevis mighthold that the burden for establishing a fraudulent conveyance has not been met and decline to enforcea U.S. court order to hand over assets in the trust. 1

B. The Caribbean Judicial Response

Caribbean courts have been as varied as their legislatures in responding to U.S. pressure to fight moneylaundering and the financing of terrorism. For instance, the U.K. Privy Council, which hears appeals fromthe Bahamian Supreme Court, has been *191 generally supportive of new anti-money launderinglegislation. The Privy Council has upheld the constitutionality of newly enacted legislation to combatmoney laundering in the face of opposition by interest related to the trust industry in the Bahamas.[FN125] The Privy Council has also upheld the revocation of a trust company’s license in response tosuspected money laundering. [FN1261 While this may represent only one company, it is alsorepresentative of the overall belief that the era of lax regulation is now over.

Another landmark case in asset preservation trust jurisprudence came in 1995 with the Bahamian caseof Grupo Torras S.A. v. Al Sabah. [FN127] In Grupo Torras, it was alleged that Sheikh Fahad, a member ofthe Kuwaiti royal family, had defrauded investors to the tune of $450 million dollars and then hid theassets in a series of asset preservation trusts in the Bahamas and Cayman Islands. [FN128] Employingthe Fraudulent Dispositions Act of 1991, [FN1291 the Bahamian Supreme Court granted a ‘mareva’injunction which froze the assets of one such trust, preventing the trust from invoking a flee clause inorder to move the assets to another jurisdiction. [FN13O1 In ascertaining the intent of Bahamianlegislators, the court reasoned:

“It seems to me that it is one thing to ascribe to the Parliament of the Bahamas (“Parliament”) anintention to make The Bahamas more attractive as a “tax haven” by encouraging the establishment inthis jurisdiction of what are referred to in some commercial circles as “asset protection trusts” but it isquite a different matter to attribute to Parliament an intention of allowing the Bahamas position as alegitimate tax haven to be used as a cover for fraudulent activity which has little or nothing to do withthe minimisation of taxes or the protection of honestly acquired assets from the sometimes

1 [This footnote is created by the Professor from the primary text: Nevertheless, St. Christopher and Nevis havealso created a Financial Intelligence Unit in order to enforce their anti-money laundering laws through cooperationwith foreign financial intelligence units [FN1231 and like their Caribbean compatriots, are no longer listed asnoncompliant regarding FATF’s forty recommendations because of their significant progress in strengthening theiranti-money laundering capabilities. [FN1241

unreasonable demands placed on those assets e.g., as a result of an award of damages against a

professional person.” [FN131I

It is worth noting that the court reasserted in Grupo Torras its belief that avoiding taxes and protecting

against some forms of liability were legitimate uses of such trusts and that is such circumstances* 192

the court would not comply with a foreign court order. Crucial to the court’s granting of an injunction in

Grupo Torras, however, was the finding that the trust was a ‘sham’ in that Sheik Fahad, as both settlor

and primary beneficiary of the trust, exerted control over the trust in a manner inconsistent with even a

self-settled trust. [FN1321 While a settlor of a self-settled trust will typically be allowed to make

investment decisions regarding the trust, Sheik Fahad withdrew money from the trust in order to pay for

membership in a country club so that he could play golf, and also used trust funds to invest in property

in the Bahamas which he ended up using as a residence. [FN133]

Grupo Torras is significant not only because of the amount of money involved in the trust, but also

because it draws a line in the sand, defining how much control a settlor can exercise over offshore asset

preservation trusts. It also clearly illustrates that offshore jurisdictions such as the Bahamas are willing

to identify fraudulent conveyances into an asset preservation trust going forward. While many of the

more legitimate uses of asset preservation trusts remain unaffected, it is now much more difficult for a

money launderer to take advantage of some of the unique features of an asset preservation trust in

order to obscure the origins of funds and evade creditors.

C. Inter-Regional Cooperation

While Caribbean legislators and judiciaries have worked independently in response to U.S. and

international pressure to combat money laundering, they have produced a collaborative effort as well.

This effort is in part, due to the recognition that if uniform standards are not maintained throughout the

region, some countries may seek to achieve an unfair advantage in their trust legislation, which would

work to the detriment of the overall goal of fighting the illegitimate use of these offshore financial

centers. [FN1341

At the forefront of this inter-regional effort is the Caribbean Financial Action Task Force (hereinafter

‘CFATF’), created as a result of a 1990 meeting held in Aruba among member-states and *193 the

Kingston Declaration on Money Laundering. [FN135] The CFATF has facilitated the signing of a

memorandum of understanding among their member states and they issue a yearly report in which they

track each other’s progress in addressing money laundering. Nations requesting to become “cooperating

and supporting nations” must express their commitment to the support of the CFATF and undergo a

positive mutual evaluation by the FATF or a FATF-approved regional body. [FN136]

***

[All] member states are now compliant with FATF’s forty recommendations and the CFATF has trained

seventy-one examiners during the past year on more stringent AML/CFT [FN138] standards for

combating money laundering and the financing of terrorism. [FN1391

Such collaboration between the Financial Intelligence Units (hereinafter ‘F.l.U.s’) of different countrieshas also been formalized by the formulation of the Egmont Group. The Egmont group...fight(s) bothmoney laundering and the financing of terrorism. [FN1421 Caribbean members of the Egmont groupinclude: Anguilla, Antigua and Barbuda, Aruba, Bahamas, Barbados, Bermuda, British Virgin Islands,Cayman Islands, Dominican Republic, Netherland Antilles, St. Kitts and Nevis and St. Vincent & theGrenadines. [FN1431

Cooperative endeavors such as the Egmont group and CFATF facilitate not only the exchange ofinformation, but also of standards governing asset preservation trust. Going forward, it is likely that thecontinuation of such cooperation, coupled with U.S. pressure, is likely to result in more uniformstandards governing offshore asset preservation trusts throughout the Caribbean.

V. A Look Into the Future

The Caribbean as a collective unit has clearly come a long way since the United States first sought tofight money laundering beyond its own shores. In the process, the offshore financial industry has seenboth the rise of the asset preservation trust in order to meet the needs of debtors, and its modification

as a means of preventing fraudulent conveyances and other forms of money laundering.

Although asset preservation trusts are still an effective means of protecting legitimately earned assetsfrom foreign creditors, IJS. pressure has clearly led to an erosion of banking secrecy laws and anysensible lawyer should keep several things in mind before establishing and operating such trusts. First, alawyer should be at least partially aware of the source of funds which enter an asset preservation trust.While willful ignorance is still insufficient to establish a fraudulent conveyance in most offshore

jurisdictions, a lawyer in the U.S. can be held liable as facilitating the fraudulent conveyance and bedeemed a co-conspirator of the fraud. [FN144] One proposed solution to this danger is to require aclient who wishes to open an asset preservation trust to sign a solvency *195 affidavit, pledging that theclient has no outstanding judgments against him. [FN1451 By requiring such an affidavit, a lawyer maybe able to absolve himself of liability if a U.S. court later alleges that he facilitated a fraudulent

conveyance into an offshore trust.

Second, although a trust that allows the settlor a greater degree of control can in many situations bebeneficial, as a result of cases such as Grupo Torras [EN 1461 there is still a real danger that such trustscan nevertheless be held shams and set aside. It is therefore essential that in drafting the trustagreement, the powers of the settlor are clearly defined and that the settlor does not exceed thesepowers in reality.

Lastly, although determining the situs of the asset preservation trust is still an important decision, asinter-regional cooperation leads to more uniform standards, the finance industry is approaching a morestandardized version of the asset preservation trust, regardless of where the trust is located. While such

a trend obviously makes the job of a lawyer easier in determining the situs of a trust, it is still too early

to determine whether this trend will also lead to a loss of some of the features which make asset

preservation trusts so desirable in the first place.

For the time being, however, asset preservation trusts are now less likely to be used as a means of illegal

money laundering because of U.S. pressure, yet they still provide both the flexibility and the protection

needed in today’s increasingly litigious society for assets earned through legitimate means.

[Footnotes Omitted]

40 UM1AIALR 169

H.R. 1265 - Summary: Stop Tax Haven Abuse Act (GovTrack.us) Page 1 of 2

G ovTrack.us

GovTrack Insider is :rnn ne iduo .jnrss o HIs in Co:igress. Check it t.

HR. 1265: Stop Tax Haven Abuse Actiii Congress

20 OCt—20 IC)

S LI mm a ri Cs

Congressional Research Service Summary

The following summary was written by the Congressional Research Service, a well-respected nonpartisan armof the Library of Congress. GovTrack did not write and has no control over these summaries.

3/3/2009--Introduced.

Stop Tax Haven Abuse Act - Amends Internal Revenue Code provisions relating to tax shelter activities to: (1)establish legal presumptions against the validity of transactions involving offshore secrecy jurisdictions (i.e., foreigntax havens identified in this Act and by the Secretary of the Treasury); (2) impose restrictions on foreignjurisdictions, financial institutions, or international transactions that are of primary money laundering concern or thatimpede U.S. tax enforcement; (3) treat certain foreign corporations managed and controlled primarily in the UnitedStates as domestic corporations; (4) increase the period for Internal Revenue Service (IRS) review of tax returnsinvolving offshore secrecy jurisdictions; (5) require tax withholding agents and financial institutions to report certaininformation about beneficial owners of foreign-owned financial accounts and accounts established in offshoresecrecy jurisdictions; (6) disallow tax advisor opinions validating transactions in offshore secrecy jurisdictions; (7)subject dividend equivalents and substitute dividends to the 30% tax on foreign income; and (8) impose reportingrequirements for transactions involving a passive foreign investment company.Amends the Securities Exchange Act of 1934 and other federal enactments to impose a penalty for failure to discloseholdings or transactions involving a foreign entity.

Requires the Secretary of the Treasury to publish a final rule requiring unregistered investment companies, includinghedge funds or private equity funds, to establish anti-money laundering programs, and to submit suspicious activityreports.

Modifies requirements for certain third party summonses used to obtain information in tax investigations that do notidentify the person with respect to whose liability the summons is issued (John Doe summons).Increases penalties for promoting abusive tax shelters and for aiding and abetting the understatement of tax liability.Prohibits the patenting of tax planning inventions.

Prohibits tax advisor contingent fee agreements for obtaining tax savings or benefits.Allows increased disclosure of tax information for enforcement purposes.

Directs the Secretary to impose standards for written tax opinions by tax practitioners.Denies tax deductions for certain fines and penalties for violations of law and for interest paid on certainunderstatements of tax.

Sets forth rules for the application of the economic substance doctrine and imposes penalties for underpayments oftax due to transactions lacking economic substance.

Becs’se the LS. ( noss ooas roost egisaCive intbuaion 00000 one ksIative drt oLer enors oeerr, GovIiack is usunIv onethistrtio ds Hhiod. For more in! rmatoo bnut where this da:a romes !‘om, son About GovTrack.us.To the this inthnuation, eiu! a eitutIoo Iorrrr tbr a suggestion: I Wikipedia TemDlate.

httn:/Iwww. ovtrack.us/congress/bi11.xpd?bi11h 111-1265 &tab=sunimary 11/7/2010

Excerpt from:

The Stop Tax Haven

Abuse Act: A Unilateral

Solution to a

Multilateral ProblemAnthony D. Todero, 19 Minn. J. Int’l L 241

(2010)

2010] TilE STOP TISHAvENMUSEACT 269

what lure international financial investors.157 The BostonConsulting Group predicted offshore assets will reach $8.8trillion by 2012, giving foreign banks a strong financialincentive not to cooperate with U.S. tax autborities.155

IV. ALTERNATIVES THAT CONSIDER OTHERCOflITREES’ m’rEEESTS

The problem is not that the Act puts U.S. interests first.’ssRather, the problem is that although the United States isdependent on other countries for tax information in order for theHIS to enforce U.S. tax po]icies,lsO the Act does not considerother countries’ interests in promoting bank secrecy.IsI TheU.S. motivation is obvious. When other countries holdthemselves out as tax shelters and guarantee bank secrecy, U.S.taxpayers cheat on their tax returns.152 This decreases the U.S.tax base by depleting financial resources that the governmentcan use to support its initiatives.’sa

Motivation for a country like Naurn is relatively simple aswell. Because Nauru’s resources are declining, one source ofeconomic security is the foreign investment attracted by thecountry’s bank secrecy laws.is4 Alternatives that considerothers’ economic interests—while not necessarily requiring thesubordination of 115. interests—are a policy that trades cash fortax information and an intsrncthrnal tcz erg Lzati;r. -:ci:domeetic enforccmcnt pcwcra.

:5’;eTTa.r,,san )!ur,nlra j’u 17?, att 1bgapors says itwilinotbathe eel iLe toueeb I:.areL:ceeeei— ::rve 3:eeeZU&rataoxts....9.

2..n C,.ooultmgGreer’

: .L’i!._•r&::- .a” ‘C-’ :

l’2:c} ‘: rUee:ein200T .1

P: a””-:!--- *;rm-to’’’ts’incerestee:re:ea;pnae’

160. See ZZa;z cc,: nct’r25, a:iC. ‘: 77ri: S-D:--: Sc:: lax :;eeCaUcS e:c,eir: Ny

— ate — — .i’ialt-’. -::::-e-:eowtort:. ‘E-S:’:. -‘

Waler, tciinthre cf:ao Oeaa:r for Public :---:r--’.- :1cc:. -:.‘ -c -: trrbtcattnre-:caaeefor,

:-—.t:—t- ‘t t’ - -

J1 -- :: Ltfl -area note !5, at

270 MINNESOTA JOURNAL OFINT’L LAW [Vol. 19:1

A. CASH oa TAS INFORMAPrON

If the United States were to purchase tax information, the

goal would not be to collect as much information as possible, but

to collect only the smallest amount of information necessary to

enforce tax laws.I65 Once the United States identified a

jurisdiction from which it needed tax information, that

jurisdiction’s willingness and ability to prowide the necessary

tax information would become an issue of price negotiation.iS6

The final price might include compensation necessary to repay

private parties and “to offset the burdens lmpose&’ on foreign

governmental actora.1s7 This market system of tax information

acuisifion takes into account another country’s nan-reciprocal

need for tax information or its inability to gather such

information. If the U.S. paid less for such information than the

amount of tax revenue that information would produce, the

system would account for all parties’ interests. By doing so, a

net importer of tax information, such as the United States, could

acquire extraterritorial tax information from a country with

relatively small amounts of collected tax information, such as

the Bahamas.’asThe current method of bilateral exchange—trading tax

information for tax information-—remains fundamentally

unchanged since before World War IL and is outdated.’ss Rather

than using sanctions to force countries into compliance as the

Stop Tax Haven Abuse Act would do, the United States might

allow the use of cash as consideration for specific tax

information.ow This would allow an importer of tax information

165. The IRS has previously limited the amount of tax information mfletted.

See Dorothy A. Brawn. Race and Class Maltera in Tax Policy, 107 COLUM. L. REV.

790, 807 (2007) (noting the end of IRS “goneral audita” according to the Taapaycr

Complianse Hoasuressant Program).165. See Dean, supro note 9, at 659 (TIThe United States mmlii regotiato with

the govornmente of these jurisdictions the speciSc nature of the information. . . as

well as regarding the price at which it woulitbe willing and able to provide 1L).

167. See Id, at 959—69.169. See id. at 611 (mating that a more complete market would allow a country to

‘nsasimize ito utility and to minimize its impact on privacy’ even if they collected

little or no information’); see also Gibson, oopra rote 54 (stating that the Bahamas

does not levy taxes on capitai game, corporate earninga, personal income, ealea,

inheritance, or dividends.’).169. See fleso, supm nate 9, at 611 (highlighting far example, that net tax

information iniportere, ouch as the United States, could acquire spectOr tax

information, rather than import homogenized information an masse, which is lees

useful tad more invasive).110. See Deass, eupra onto 5, at 511.

20101 TIlE STOP T4SHAvEivABusEAcT 271

to acquire tax information ox post, thereby decreasing theprivacy concerns associated with the shipment of tax data.rii

However, the possibility of market failure still exists in thiscash-for-information system. For example, the fair price forinformation might exceed the revenues generated by theacquisition of information or a bilateral monopoly might preventa more complete market.17l Even though a purchaser of taxinformation would acquire tailored information making privacyless of a concern, a nonmarket solution might provide morerobust privacy protections than a market alternative.’ii Agovernmental alternative might avoid market failures.

B. A Nw MuLnsntnaL TlJSTITUTION

Because leaders have political and financial incentives toact in nationally eelf-interested ways, a tranenational body withdomestic tax authority could overcome the problem ofextraterritorial tax information acquisition.’74 Such atrananational actor would need to have powers on par with thedomestic capabilities of national tax authorities, which wouldimpinge on traditional notions of national sovereignty.ne

171, With the increasing advent of identity theft and hackers, the case farlimiting the infermation sent to the illS is strong. See Rosaat F. DAolry,Govzateogeorr Accoubrosantry Omcs, RErowr tO tan Sueooseoaivrzz ONTzcsaownv, ltwossas!noa Poxacy, lsry,soovssnoezsta Rsistlows, nm taxCissus: INFoaMAnON Sscuxn’Y: Psoosnas MAnE, BUT WEAKNESsES Ar tagIterglnoAl, Rxvxosug Snavica CONUNUE to Foss Risxs (2005), reprinted in TAXAsayers, Qoea Tsx Nocss TODAY 106.12 at 6—7 (2081); see generally Peter P.Swire, Financial Privacy and the Theazy of High-Tech Government Surveillance, 77Wa Ti. LQ. 461, 497 (1999) (“The possibility of intrusions. . .is a pewerfelargument against allowing anlimitad varnment access to sensitive personalinformation of any bn&”). There is Mao the risk that sn IRS employee mightconduct an unauthorized eearch of an individuaTh tax iukxmatloa See AndreaCeembea, IRS Employee Sentenced for Snocpinw Tax Maze Eyet Thx Rerorde ofAlmost 201) Celebritiee, Including Kevin Bacon, MAXK5TWATCII. Aug. 20, 2008,httpalwww.marketwatckcom/eews/etooyliee’werker.onooped-tax-ncerdslatorax?guld=473sBACan-C5sF4siB-AF11.asC21o1E7CPs)&diat=niar1.

172, See RlcaAie S poaans, EcoNoMic ANatsis OF LAW § 8.8, at 62(8th ect2003) (noting that a bilateral monepaly occurs and muses high transaction malewhen neither party has a beneficial alternative to “dealing with the ether”).

178. See generally Peter P. Swire, Traaleerap: The Importance of Legal Rules IsElerlronec Commerce and Intencel Privacy, 54 HAS7nIO5 L,J. 847, 860-73 (2008)(discuaaing the importance ef privacy protection in the Internet era).

174. See, zeg., Vito Taxi, Globalization and the Work of Fiscal Termitea, ss Fm.&Dav. 1, Mar. 1, 2008, httpllcrww.iderg/externaligubelWfaaddr200lloa/tanzihta(acting the distant, and mere utopias, peeelhllity of a world tax ergenizatiec thatwould facilitate the international cetactian and distribution of tax revenues).

175. See Ronen Palan, Tax Haversi aad the CommercializatIon of Slate

272 MI1’1NESOl’A JOURNAL OF INT’L LAW rVoL l9l

Recently, two existing international organizations, the United

Nations and the OECD, have vied for leadership of a new global

tax authority.178 Both the United Nations and the OECD axe

capitalizing on their history of work aimed at increasing

international tax cooperation.177 In theory, either organization

could fill the gaps generated by the current patchwork system of

bilateral t5x treaties and avoid the inequity of the multilateral

conventions on tax information acquisition. Iii practice,

however, the reality is much different.The OECD’s exclusive membership fuels non-members’

perceptions of discrimination in the• development of

international tax rules.1ls This generates a perception of

illegitimacy whereby large powerful countries dominate smaller,

weaker ones in the realni of tax policy and enforcement.175

Although the OECD might have more power then the United

Nations to enforce an international tax regime, it lacks the

necessary international legitimacy because of its membership

makeup, which includes historically powerful nations, such as

the United States, France, Germany, Portugal, Spain, Italy,

Japan, and the United Kingdcm.18o While the United Nations

might have greater international credibility as a fair arbiter of

Sovereignty, 56 INra Oea. 151, 178 (2502) (nathig that such an organization might

spell the n4 of the traditional Westphalian ytm of sovereignty).

176. Dean. eupra note 9, at 661—62.177 Sea, ag, U.N. Dep’t of Int’l Scan. & Soc. Affaira, U.N Model Double

Taxation Convention Between Developed and Developing Countries, U.N. Dec. No.

ST/ESW1O2 (1960), rep,-iavted ire S7ANIZY S. SURREY, United No4one Model

Convention for Thx Treatiee Between Developed and Developing Countries: A

Description and Analysis, inS HAxV. L.ScH. tN7’L nI PROGRAM & 1N1L BUREAu 0?

FiscAL DocuMRorrA’rIoN, Sal,EoranMOeaoGRel’Rs ONTAYATION 67-113 (1980),

178. See Arthur J. Cotkfiald. The Rise of the OECL) as informal ‘World Ta

Orgonizatiaro” Thea ugh National Reoporoseo to E.Ccmmerce Tax Challenges, 8 Yiz

JL & TzcH. 136, 185-86 (2006) (arguing that extending OSCO membership to,

dirent countries will help to allay cencerns that the OEOD has been ‘captured’ by

multinational firms booed in OECD countries” and noting that “the perceived

influence of these firms nay be reclucengtlw legitimacy and effectiveness of OECD

refoesn efforts.”); tAtt.]ewood, supra note 09, at 480-85 (deeea’lbing pitfalls to ChOP

reform efforts, including the fact that tue membership is not viewed us

representative of the entire world).179. See Alexander Townsend. Jr.. Conunent, The Global Schoolyard Bully: The

Organisatiorv for Economic Co-Operation and Deuelopmenls Coercive Efforts to

Control Tax Competition, 25 PoRDaM,i INt’l U. 215, 261-68 (2001) (arguing that

the 1968 and 2000 OSCI) reports ‘mark a coercive and intrusive solution that

deviates from traditional 8cal remedies.”).120. Dean, aupra note 9, at n.570: tee ales Littlewood, aupro note 69. at 480-25.

Pot a list of OBCD member nations, sos Org. for Scan. Co.operatin & Dcv.,

RaliScatton of the Convention on the OECD. http:/lwww.ab05.eomIOECDJ.htoil (last

visited Nov. 2, 2009).

2010] THE STOP TAX HAvENABuSEACT 273

international tax controveraies,18l it lacks sufficient power to bea la-ananational tax enforcer.i82 Countries, especially the UnitedStates, might resist the necessary curtailment of sovereignty forinternational tax enforcement.18a Realizing its incentives toresist U.N. enforcement authority, the United States mightrecognize other countries’ similar incentives to work against thesuccessful enforcement of a U.S. dominated multilateral taxregime such as the OECD. Thus, tax evasion is a globalproblem requiring a global solution. 154

V. CONCLUSION

Globalization, the September 11th attacks, and two recentscandals have put tax havens in the legislative crosshairs, TheObarna Administration fully supports the Stop Tax HavenAbuse Act.155 Because of President Obama’a unqualifiedsupport, the political popularity of cracking down on tax evadersin tough economic times, and banks’ decreasing ability to fightagainst such measures, the Act is likely to pass. Thecenterpiece of the Act is a list of offaliore secrecy jurisdictions.Although some of the motives behind enacting such legislationare laudable and some of the Act’s provisions are commendable,the Act is unlikely to garner cooperation from countries vital toits success. The Act fails to account for other countries’economic interests. Although alternatives are not perfect, theyare preferable. A market solution, such as allowing the United

181. See U.N. Aol Hoc Group of Experts on lnL’l Cooperation in Tax Matters,Ixetilstfonol Franewark for I vncotioncl 7bx Cooperation, 1 5-10, at 4-5, U.N.Dec. STISGIAC.8!20001L.0 (iosg 19. 2093), available aS btterildaceesedds,unorg/dod

DCC N03145] 851PDF1N0348139.pdflOpenElemont (‘The United Nationsbee recognized for some time the need to give the developing and transitionalcountries a voice in the dinnulation of international tel norms.’).

192. See OenaAo Hothaway Between Poser and Principle’ An Integrated Theoryof lntornutioni Law, 72 U. CIII. L REv. 469, 606 (2005) (noting the weabness of theUnited Notions ability to enfosee compliance).

183. See e.g Daniel Mitc.befl, UJ Tao Police PotenEo.l, Wean Tacos. Feb. 7,2002, at AIR (expressing concern that a U.N.-led international tax organicationwould be costly to the United States).

184. See Plan, eupra note 178, at 173 (‘fAJny aerious attempt to combat the taxhavens phenomenon would have to be condacted on a multilateral level,”); see alsoMiemaL VAN Dr.nc & FRANCIS Wgyzio, Toes GLoEAL PRLISLEM OF TA HAVENS: ThECASE 00’ TSE NEmERLANDS S (Sticlsting Ondewek Multintioiiale Onolernamingen(Centre for Research on Multinational Corporations) 2008) (2007) (arguing that theNetherlands must end harmful lox poiieiee but that the tax haven problem requiresa global solution).

189. Drawbaugh & Daly, sispro note a.

274 MiNNESOTA JoURNAL OFIN7L LAW IVoL 19:1

States to purchase tax information from other countries, or anintergovermnental solution, such as a World Tax Organization,would facffitate a greater exchange of extraterritorial taxinformation and bolster the enforcement of U.S tax laws.

COUNTERTRADE

AND

THE CARIBBEAN

58 MONEY, CURRENCY AND FINANCE cil.i

dollars a day is settled through the U.S., most of it through CHIPS.

[9] Countertrade

In a count,ertrade transaction, one party accepts goods or services as

payment for its products instead of currency. Typically, a countertrade

transaction involves commercial parties from two different countries.

Countertrade is often used in transactions where credit or convertible currency

is unavailable. It may be a resourceful way to arrange the sale of a product into

a country that cannot provide payment in hard currency. The lack of foreign

exchange may be specific to the buyer or may stem from the country’s limited

reserves.

Countertrade transactions are often facilitated by trading through an

intermediary, such as an international broker, international bank, or export

management company. These facffitators, however, can increase the transaction

costs. A countertrade transaction also may involve additional risks regarding

delivery and performance because of the time difference between each party’s

obligation to perform. It may be wise to draft separate contracts for each part of

the contract, rather than have one contract that makes the two parts

interdependent. The separate contracts can be linked by a separate

countertrade document.

The U.S. Department of Commerce (DOC) maintains that “the U.S.

Government views countertrade as generally contrary to an open, free trading

system but will not oppose participation by U.S. businesses in countertrade

transactions unless such activity could have a negative impact on national

security. All normal import and export regulations must be observed, as there

are no special exemptions for countertrade. transactions.” Despite this negative

opinion of countertrade, the DOG’s export support program offers assistance to

parties involved in or seeking countertrade transactions.

UNCITRAL has published a Legal Guide on International Countertrade

Transactions.

[a] Barter

An ancient form of countertrade is barter, in which no money is used but the

parties simply exchange merchandise directly for other merchandise or

services. This may occur through a swap of one product for another or by

switching products through a chain of merchants in different markets. Barter is

infrequently used in contemporary trade because of the difficulties in matching

the goods each party needs and in determining the values of the goods.

[N Counterpurchase

A more common form of contemporary conntertrade is referred to as

counterpurchase. In this transaction, an exporter purchases goods from a

country in exchange for that country’s purchase of an equivalent valued amount

of the exporter’s product. Counterpurchase also may be conducted through

separate parallel trade transactions that are contractually linked. For example,

§ 1.02 REGULATION OF INTL FINANCIAL TRANSACTIONS 59

a contract may agree to pay the U.S. exporter in a convertible currency if theexporter (or another designated party) agrees to subsequently purchase anequivalent value of goods from the importing country using that currency.

A counterpurchase contract separates the timing of each party’s contractperformance so that one transaction can be completed even though the secondtransaction requires additional time. The participating parties sign two separatecontracts that specify the goods and services to be exchanged. Thus,counterpurchases can be useful if performance depends on a future event, suchas a harvest.

As an example of a counterpurchase, assume that Country X has abundantrice but needs computers from the U.S. It is unlikely that a computermanufacturer will need rice, so a barter transaction is not feasible. However, ifa U.S. cereal producer can be involved, the transaction may be structured tohave the computer manufacturer ship the computers to Country X which in turnships the rice to the cereal producer. The cereal producer then pays thecomputer manufacturer.

[ci Buyback, Offset and Swap TransactionsIn a buy-back arrangement, a seller of capital equipment or technology may

accept partial payment in products manufactured with their equipment.Typically, the seller receives some currency in addition to the products. Forexample, a steelmaker may sell steel to a foreign auto parts maker and then buythe parts at a reduced price. The effect is to partially pay for the auto parts withsteel. A production shari’ng arrangement is similar to a buyback, but used inmining and energy projects in which a developer will be paid a share of the mineor well output.

An offset transaction is often used between countries that are involved in highvalue industrial contracts, such as aerospace or military industries. It is quitecommon in civilian and military aircraft contracts. The contract involvesreciprocal trade agreements in which the seller of a product made in onecountry agrees to purchase a specified amount of goods from the other country.For example, Country X agrees to pay $1 billion for airplanes made by acompany in Country Y if that company buys an equivalent amount oftelecommunications equipment from Country X. These contracts are designedto offset the adverse effects of large foreign purchases on a country’s balance oftrade. The arrangements often require certain portions of the product to bemanufactured or assembled in the purchasing country.

The contract may be an indirect offset, meaning that the goods and servicespurchased are unrelated to the products being sold. In a direct offset contract,the goods on both sides are related, usually involving a form of co-production,license or joint venture. Developing countries often use offset contracts tofacilitate technology transfers, providing goods or services in exchange forresearch and development, technical assistance, or patent agreements.

Swaps are relatively new arrangements that are used in countries that carrylarge debt burdens. The debt may be swapped for other items such as equityinterests in local industry or local products. In some cas the debt may be

FAcEB00K 2 BLACKBERRY AND DATABASE TRADING SYSTEMS: M0RPHING SOCIAL

NETwoRKING TO BUSINESS GROWTH IN A GLOBAL RECESSION

Roger M. Groves’

“While Facebook’s international audience totaled 34 million people at the beginning of

2008, on the first day of 2009 that number had increased to 95 million - nearly 70% of the total

Facebook audience.”2

I. Introduction

Facebook now has applications to the Blackberry Smartphone and iPhone. That

expansion has sparked Facebook’s international explosion.3 If the Facebook social networking

technology has applications to Blackberry, why not business?4 Can the Facebook model of data

sharing be customized to propel U.S. technology firms into new international markets? This

article claims the affirmative, through a multilateral clearing system, with credits and vouchers,

as part of the exchange of a commodity and the creative use of an evolving trade practice termed

“countertrade.” The voucher system envisioned is not dissimilar to the successful use of

environmental tradable credits that provided incentives to major corporations to stop using

Roger M. Groves is an associate professor at Florida Coastal School of Law, former tax judge and equity partner at

Howard & Howard, Attorneys P.C. Emphatic appreciation is extended to Sean M. Murray and Sean M. Murrell for

their valuable contributions as research assistants.2 Justin Smith, The Facebook Global Market Monitor: Tracking Facebook in Global Markets,

http:/Iwww. insidefacebook.com/facebook-global-market-monitor (last visited June 9, 2009).

See Facebook Surpasses 175 Million Users, Continuing to Grow by 600k Users/Day, Feb. 14, 2009,

http://www.insidefacebook.com/2009/02/14/facebook-surpasses- 1 75-rnillion-users-continuina-to-grow-bv-600k-

usersday/ (last visited June 9, 2009). (noting that in February of 2009, if Facebook were a country it would be the

sixth most populous in the world and that Facebook’s monthly growth accelerated by at least 25% in 30 countrEes in

January 2009 vs. December 2008) (emphasis added).

Blackberry is commonly regarded as a businessperson’s phone-plus device of choice. See PRLog, 2 BlackBerry

models try to answer iPhone, http://www.prlog.org! 10155 037-2-blackben-models-t-to-answer-iphone.html (last

visited June 9, 2009).

1

not, Facebook is value added to its members in making available OCP data for its Facebook

users. As the previous example illustrates, all of these social network relationships described in

the Facebook Terms of Use — customers, OCPs and Facebook — have broader business

applications in the international trade transactions.

V. FAcEB00K INTERNATIONAL GROWTH

A. Business Opportunities as a Multilateral clearing System

The insatiable appetite for profitability may lead a U.S. firm to tap into the expertise of

others as business partners in efforts to increase market share. Facebook is no exception. Its

business partners were software developers. Its hope was to increase profitability through new

applications and expand into new international markets.53 Thus far, the plan has legs. Facebook

has recently experienced international growth in ways most business ventures only dream of.54

There are numerous illustrations of the global Facebook explosion. During 2008 alone, Italy

experienced growth of 2900%. Now, approximately 8.5% of the Italian population accesses

Facebook, making Facebook the fourth most trafficked website in Italy.56 The 2008 year also

The term “applications” refers to Facebook applications. A FaceBook application is defmed as a platform fordevelopers which provides a framework to interact with the core Facebook features. Facebook applications havedetailed descriptions, users ratings and reviews, wiki pages, detailed features, and screen shots. See Servepath.com,Glossary of Dedicated Server Hosting Terms, http://www.servepath.cornlsupportldefinitions.php (last visited June16, 2009).

Facebook started 2008 with 5 million monthly active mobile users. By January 2009 over 20 million users wereactively using Facebook through mobile platforms. Additionally, growth continues to spiral upwardsinternationally, particularly in Europe and South America. See Insidefacebook.com, Sandberg: 20 Million UsersNow Accessing Facebook Through Mobile Platforms, http://www.insidefacebook.com/2009!01/09/sandberg-20-million-users-now-accessing-facebook-through-mobile-platforms/ (last visited June 16, 2009).

See Justin Smith, The Facebook Global Monitor: Tracking Facebook in Global Markets,http://www.insidefacebook.cornlfacebook-global-market-monitor (last visited June 16, 2009).56 See Facebook Growth Surges in Italy: Developers Look for Better Italian eCPMs,http:Hwww.insidefacebook.comI2008/12R 8/facebook-growth-surges-in-italy-developers-look-for-better-italian-ecpms (last visited June 16, 2009).

14

7L+

brought Facebook an increased penetration of 600% in Spain, 400% in France, 400% in

Switzerland, 2000% in Argentina, and 600% in Indonesia.57

Facebook applications have been developed for iPhone and Blackberry Smartphone

users.58 At least one million Blackberry users have already downloaded Facebook onto their

respective devices.59 The “application” or connection between Facebook and the Blackberry

device is not developed by Facebook.6°Facebook oniy provides the link and does not claim

responsibility for the application of Facebook to the device.61 Rather, an independent software

developer provides the application connectivity. In the case of the Facebook-Blackberry

arrangement, the software developer is Research In Motion, Ltd. (RIM).62 The Facebook

website provides the following description of RIM’s business activity:

“Research In Motion is a leading designer, manufacturer and marketer of innovative wireless

solutions for the worldwide mobile communications market. Through the development of

integrated hardware, software and services that support multiple wireless network standards,

RIM provides platforms and solutions for seamless access to time-sensitive information

including email, phone, SMS messaging, Internet and intranet-based applications. RIM

technology also enables a broad array of third party developers and manufacturers to enhance

their products and services with wireless connectivity to data.”63

Thus, for international Facebook applications there are intellectual property rights of two major

contributors to be protected, Facebook and its software developer. If members of an

international exchange network of businesses existed, Facebook may need to engage the services

See supra note 46.58 See e.g., Facebook, I tp://www.facebook.comJapps/app1ication.php?id=2254487659&refs (last visited June 16,

2009).See Natasha Lomas, Facebook for Blackberry racks up a million hits,

http://networks.silicon.comlrnobile/0.39024665.39 181 364,00.htm (last visited June 16, 2009).60 http://www. facebook.corn!apps/app1ication.php?id2254487659&reis61 See Facebook, http://www.facebook.comJapps/app1ication.php?id2254487659&vinfo&viewO (last visited

June 17, 2009).62

63

15

,75

1’9

of a software developer and contractually allocate rights between them. Very likely, the software

developer would license the software to Facebook in exchange for royalty payments.

Then, using the same type of provisions from its existing Terms of Use, Facebook would

detail the relationship between the Facebook, OCPs and the business customer. Business users

of the site would not have extraction and tinkering rights to the Facebook/Software Developer’s

site content any more than the individual social networking users unless authorized by Facebook.

B. The Role of the Multilateral Clearing System (MCS)

While barter exchanges are centuries old, they are an evolving and growing part of

international countertrade and have found a place in multilateral trading among information

technology firms.64 The generic formulation of this system involves the following parties:

I. An exporter of goods and/or services (a U.S. firm in this model) who is also willing to

purchase goods or services in exchange.

2. A clearinghouse that takes title and risk of loss of the goods.

3. An international off-shore entity, willing to purchase or sell goods or services with the

U.S. exporter and other exchange members.65

Both the U.S. exporter and international buyer agree to be part of the exchange system where the

clearinghouse processes a cash payment, or a voucher/credit, or a combination of these items as

the return payment for their respective goods and services.66 That clearinghouse entity also finds

the market for the goods supplied to it by the exchange participants.67 An example is a U.S. firm

64 See George Cassidy, Financing Strategies- Barter’s Rebirth, EAST/WEST COMMER5ANT, Dec.1, 1995, available at1995 WLNR 4072109.65 See, e.g., id.66 Id.67 Id

16

with excess inventory, or a firm with a product that is no longer as marketable or available in the

U.S. due to a change in U.S. environmental or food and drug regulations. The U.S. firm does not

have expertise or business affiliations in international markets. Yet, it nonetheless desires to find

a market for those products and thereby generate profits rather than losses.

In the clearinghouse, the U.S. firm finds an entity that has international resources and

expertise as well as a network of potential purchasers of the U.S. firm’s excess or economically

obsolete goods. Since the clearinghouse takes title and assumes the risk of loss for the product,

the U.S. exporter has minimized its risk. All the clearinghouse requires is that the U.S. exporter

store, insure and incur the risk of loss until the goods are delivered.68 The clearinghouse is

termed the multilateral clearing system (“MCS”). The graphic description of this basic system is

below:

CASH ANDVOUCHERS

GOODS /SERVICES

STORE, INSURE AND SHIP (CIF TERMS) TITLE AND RISK OF LOSS

NEW MARKET/

68 These are traditionally accepted tenns in transport, known as C.I.F., for cost, insurance, freight, all at the expense

of the seller until the goods reach an agreed destination. See RALPH H. FOLSOM ET AL., INTERNATIONAL BUSINESS

TRANSACTIONS 2 (9th ed. 2006 Documents Supp. 2006).

17

The U.S. exporter may use the cash and/or voucher and credits for any number of purposes to

fulfill other business needs. Vouchers or credits may be tradable for office equipment or

construction services if’, for example, the U.S. entity is planning a plant expansion or is starting

up with minimal capital. Some credits and vouchers could even take the form of travel or other

perks to reward employees or clients.69 From such use, an exchange member may find enhanced

firm goodwill, increased retention of existing highly-valued employees or clients, or future

clients who also see value in such voucher arrangements.

Vital to the value of the MCS is its ability to bring entrepreneurs into the same MCS

system in a way that expands each firm’s sales beyond its own preexisting client list. The MCS

model is designed to expand a firm’s sources for future revenues beyond what the firm otherwise

gains on its own. The MCS system transforms a simple barter among two parties into a multi

faceted MCS. As one commentator summarized, “Today, simple barter has blossomed into the

sophisticated system known as countertrade. . . . And that has, in turn, nurtured a new breed of

entrepreneur, the expert who can form a chain of buyers and sellers so that, eventually,

everybody gets what he wants.”70

A simple hypothetical two-party barter may be between a construction contractor that

needs office equipment and a manufacturer of office equipment that needs a small plant

expansion. They could exchange products and no sophisticated MCS model would be necessary.

If, however, party A is a person or small company with a U.S. patent of a pharmaceutical product

that cures a disease found mostly in developing countries, that patent holder may find valuable a

69

° RALPH H. FOLSOM ET AL., INTERNATIONAL BUSINESS TRANSACTIONS 252 (9th ed. 2006) (quoting excerpt of articleBack to Barter from ICC BUSINEsS WORLD, Summer 1983, p.6).

18

network already versed in the customs and practices of developing countries, assuming those in

developing countries also have something of equivalent value to offer the patent holder.7’

C. FacebookasanMCS

The value added services of the MCS are several and are perhaps best illustrated through

this attempt to customize the MCS to Facebook. Obviously, the system is ultimately designed to

provide the chain of buyers and sellers. So, imagine if Facebook’s owners decided to expand its

international client base beyond socially networking individuals sharing personal photos and

messages via personal mobile phones and computers to businesses sharing and downloading

business E-signed documents, graphics and images. What would prevent the Facebook MCS

from using computer technology and global marketing techniques to allow businesses in

different countries to exchange products and services through the above system of cash and

credits/vouchers? What would prevent Facebook, already expert at overseeing a value-added

social network exchange, from overseeing a value-added business network exchange? Facebook

could indeed establish a chain of buyers and sellers so that credits earned by one seller could be

exchanged for the services of another entity in the exchange network. The vouchers or credits

could be used to swap for anything from raw materials, capital equipment, supplies, and

worldwide services for travel, accommodations and advertising.72

71 An example may be the patent holder’s desire for patients for further studies, paid for and provided by the one or

several developing countries. The developing country could itself be a member of the MCS exchange system. The

patent holder may then earn vouchers as a credit to exchange with several of those countries.72 See George Cassidy, Financing Strategies- Barter y Rebirth, EAST/WEST COMMERSANT, Dec. 1, 1995, available at

1995 WLNR 4072109.

19

The graphic depiction of the exchange network is below:

CASH ANDVOUCHERS

GOODS /SERVCCES

VOUCHER SWAPS

NEW MARKET

One MCS provider devoted 100 persons in a New York office to essentially three tasks:

(1) making deals, (2) re-marketing inventories, and (3) paying companies that are part of the

exchange network.73 Among the million-plus and growing Blackberry owners who have already

downloaded Facebook, isn’t it likely that many are using the Blackberry for business purposes

already? And, if Facebook devised an application for business as seductively attractive as its

social network tools, is there not also vast potential for an MCS through Facebook? Instead of

connecting with college alumni, a firm could connect with exchange members who have been

careftully selected and categorized for their mutually beneficial aspects.

See George Cassidy, Financing Strategies- Barter’s Rebirth, EAsT/WEST COMMERSANT, Dec.l, 1995, availableat 1995 WLNR 4072109.

20

Some firms may argue that they are just as capable of finding business partners from

search engines and websites of those same business clients. This Facebook MCS is not

suggested as ideal for all. Perhaps some large, well- healed firms can afford significant

international networking resources and have the ability to select and arrange information in a

user-friendly maimer that attracts a multitude of entities that connect with each other. But, at

least on the social networking side of transactions, no one has done it like Facebook.

There are various challenges in an international transaction. Facebook’s clearinghouse

function would offer each member the value-added service of being the customs, cultural, and

legal translator to facilitate the international transaction. Unlike the United States, some nations

mandate the designation of a local agent for the distribution of goods into that country.74 Such

provisions are non-waivable by contract between the parties. Even distribution agreements may

be severely restricted.75 Facebook could screen credible from unscrupulous agents by

recommending or certifying agents via its role as an MCS provider. Similarly, U.S. firms may

face anti-Americanism or related cultural issues occasioned by fear of exploitation of another

country’s cultural or natural resources.76 Countries currently struggle with whether to even allow

social networking sites to operate within their borders.77 The similar issue may face a business

variant or division of such sites. Facebook could be the more culturally-friendly face of America

with certain trading partners, and could play a lobbyist role as well. Indeed, the MCS is

essentially a vehicle designed to fulfill the goals articulated by various nations in a recent treaty:

to facilitate international multilateral commercial transactions and affirm the goal of “upholding

RALPH H. FOLSOM ET AL., INTERNATIONAL BUSINESS TRANsACTIONS 239 n.4 (9t1 ed. 2006).

n See id. at 23 8-243.76Seeid. at 10-11 n.1.

See CNN.com, Iranians Regain Access to Facebook, Twitter, May 26, 2009,

bttpi/www.cnn.comJ2009/WORLD/meast/05/261iran.facebook1index.htm1 (last visited June 20, 2009) (discussing

the recent shutdown of Facebook and Twitter in Iran).

21

and safeguarding an open and non-discriminatory multilateral trading system.”78 Similarly, the

goal of the MCS in countertrade transactions is to increase transactions among firms from

various countries, particularly parties new to technology transfers fiom developing countries.79

And to achieve that goal, the MCS can assist in the effort to solve soft currency or liquidity

issues through voucher credits and carefluly matched exchange partners.8°

And, rather than each member paying each of its respective counsel, would not each firm

contemplating international transactions prefer a specialized legal group that combines the

cultural filter with the required international documents? Bills of lading, letters of credit, and

the above-noted agent rules of particular jurisdictions are but a few of the specialized areas that

would be involved in such transactions.8’If Facebook provided the legal team a small portion of

the transactional fee charged to facilitate the transactions, it could both provide and subsidize

these quality legal services.

The Facebook legal team would, for example, provide value to exchange members if a

foreign nation requires a foreign distributor or agent resident to that country in order to sell

goods in that country.82 The legal team may therefore draft an agreement to parse out the

relative rights, responsibilities, liabilities, and representations arid warranties between that

78 See World Trade Organization, Ministerial Declaration of 20 November 2001, WT/MJN(0 1)/DEC/i ¶ 6, availableat http://ww’.wto.org/english/thewto e/ministe/mino I e/mindecl e.htm.

“Technology Transfer” refers to the sale or licensing of intellectual property, or the field involving the sale andlicensing of intellectual property. See BLACK’S LAW DIcTIoNARY(8th ed. 2004).80 “Soft Currency” refers to currency that is not backed by reserves and therefore subject to sharp fluctuations invalue. See BLACK’S LAW DICTIONARY(8th ed 2004). Soft currencies are not in demand in world markets. Seeh:/!www.anz.com/edndictiona’.asp?actioncontent&contensoft currency (last visited June 20, 2009).81

A bill of lading is the official document prepared by the carrier duly accepting the goods for shipment containinginformation like item quantity, value, vessel details, date, port, consigner, consignee etc. The bill of lading is thecontract to carry the goods to the said destination based on which seller can claim consideration and buyer can takedelivery of the goods. See Legal-Explanations.com, http://www.legal-explanations.com/definitions/bill-oflading.htm (last visited June 20, 2009). Letters of Credit are documents issued by a bank that guarantee the paymentof a customer’s draft. In essence, letters of credit are instruments used to substitute a bank’s credit for that of thecustomer, who, in international transactions, may be unknown to the seller. Seehttp://wordnetweb.princeton.edu1perl/webwn?sletter%20of%20credit (last visited June 20, 2009).82 See FOLSOM, supra note 65, at 239.

22

exchange member and its foreign agent or partner. Within an international agreement, those

rights may obviously include the licensing by the foreign distributor/agent (“partner”) of the U.S.

software developer’s technology. The traditional protections of that technology under U.S. law

are through patents, copyrights and trademarks.83 While there are varying rights among the three

protection types, the trademark licensing is at the core of most international franchise agreements

and Facebook would protect the exchange member’s rights in the foreign agent agreement. 84

What may also separate Facebook from the individual exchange member or other MCS

providers is its seemingly unique connectivity with the younger generations, which translates

into the, say, under fifty-something entrepreneurs, which now includes Twitter.85 That younger

business segment may also be the plasma for innovation in technology. They may be the

business generation most likely to be using the Blackberry Smartphone or iPhone as it evolves

more business applications. That segment may therefore embrace rather than shun the electronic

transmission of important international documents like a letter of credit or bill of lading, and may

accept the related E-signatures on such documents.86The types of goods and services to be

exchanged (apart from the voucher swaps) may increasingly be software or other intangible

property from this creative database generation of entrepreneurs.87 Facebook may have goodwill

with developers and other electronically sophisticated entrepreneurs since Facebook itself is an

entity that was born into and profited from its internet acumen.

83 See id. at 790-99.841d. at 790, 801.85 Facebook does not have a patent on youthful entrepreneurism. Twitter’s three co-founders are all in their 30’s and

incidentally they did not depend on traditional criteria for business success. They were all college dropouts. See Jon

Swartz, A World That’s All a-Twitter,USA TODAY, May 26, 2009, at Bi. But the point is the same. There is a

generational dynamic to information technology modeling. This article attempts to incorporate that dynamic in

modeling future international business transactions in periods of global economic stress.

86 The Electronic Signatures in Global and National Commerce Act of 2000 establishes the legal equivalency of

electronic contracts, electronic signatures, and other electronic records with their paper counterparts. See BLACK’S

LAW DICTIONARY(8th ed. 2004).

87 For further description of these entrepreneurs, see Groves, “Gen GT: Future Business Ventures in Global

Technology and Entrepreneurs of the Data Sharing Generation” at SSRN:

_______

23

D. MCS Benefits

For the MCS exchange member, the benefits of a Facebook MCS can be summarized as

follows: (1) developing a new market! customer base, (2) the ability to sell excess capacity or

domestically obsolete commodities, and (3) converting losses from that excess capacity into

revenue or needed goods or services.88 The exchange is essentially an alternative to cash but

achieves the same purchasing power as a form of currency; thus it conserves cash.89 And,

conserving cash can improve cash flow since there is more cash then available for other business

purposes 90

As stated earlier, the Facebook MCS may not be well-suited for every international

business firm. But if a firm is among the U.S. small and medium sized businesses in

international trade without the resources or expertise to build both a customized network of

purchasers of its product or a qualitative legal team for those transactions, the Facebook MCS

may be advisable.

E. C’apitalization of the Entity

The capital needed to establish and maintain such an MCS is typically generated from the

following primary sources: (1) existing reserves dedicated to expansion, (2) monthly fees from

members in the exchange, (3) website advertising, and perhaps most significantly (4) a

88 See Cassidy, supra note 64.See Michael Joe Medill, Illinois Trade Association Acquiredfor $4 Million, DAILY HERALD (Arlington Heights,

IL), October 5, 2006, available at 2006 WLNR 24575069.90 Id.

24

transactional fee for each commodity exchanged.9’As for the potential for advertising revenue

from the Facebook MCS website, its considerable market penetration from being one of the most

trafficked sites on the planet provides an attractive lure to advertisers. Each exchange member

could also advertise. Each outside entity that desires the exchange members as clients could

advertise. Beyond advertising, each transaction facilitated by Facebook would generate a fee for

the customer’s use of Facebook’s many value-added features described above.

As stated by one executive of an exchange company, “Today, business is conducted in a

borderless world and barter is an effective tool for companies to expand and penetrate global

markets, and grow their bottom line.”92

VI. THE INTELLECTUAL PROPERTY RIGHTS OF FAcEB00K AND MCS MEMBERs AS

DATABASE CREATORS IN INTERNATIONAL TRANSACTIONS: HARMONIZING THE

INTELLECTUAL CREATIONS OF THE MCS PARTIEs

A MCS can only effectively function if there is clarity in the legal relationships among all

participants in the system: i.e. the exchange members and Facebook as facilitator. Only by

knowing the relative rights in their respective property can a member then enter into assignments

of interests and license agreements regarding those rights. Obviously, conflicting claims or

uncertainty over the parties’ respective rights in specific property and the extent of protection of

that property could thwart the buying and selling of goods and services in this transactional

format. The focus in this writing is on the facilitator, Facebook, which lies at the heart of the

transaction and quarterbacks the team of traders.

91 See Michael Joe Medill, Illinois Trade Association Acquiredfor $4 Million, DAILY HERALD (Arlington Heights,

IL), October 5, 2006, available at 2006 WLNR 24575069; Penni Crabtree, About 400,000 Companies Barter Goods

or Services Each Year, THE SAN DIEGO UNION-TRIBUNE, March 26, 2008, available at 2008 WLNR 5816844.

92 Thriving on Barter, BUSINESS TIMES (Singapore), October 30, 2006, available at 2006 WLNR 18781084.

25

The Changing Role Of Countertrade And Other Contract-Based Practices In International Trade *

Extract of paper presented at the International Trade and Finance AssociationSixth International Conference, San Diego, May 22-25, 1996

By: Pompiliu Verariu, US. Department of Commerce,International Trade Administration

(* The views expressed in this text are those of the author and do not necessarily represent those of theInternational Trade Administration, the U.S. Department of Commerce, or the U.S. Government.)

Following the emergence in the mid-1970s of countertrade transactions in trade with the thencommand-economy countries of Eastern Europe and the Soviet Union, the practice proliferated rapidlyand, by the end of the 1980s, had spread geographically to over 100 nations.

Countertrade deals would typically entail two contractually-linked import/export transactions, eachsettled through letter of credit payment.

In the belief that countertrade arrangements could alleviate net outflows of scarce hard currencyresources and help finance critical imports, many developing country governments enacted legislationwhich enabled private sector enterprises--or directed state-owned enterprises--to participate incountertrade deals.

For many hard currency-strapped Third World countries struggling to cope with the rising prices of theirenergy imports, linking imports from industrialized countries to domestic exports seemed like areasonable way to finance the imports and expand exports.

Bilateral trade under government-to-government clearing agreements was, after all, the way much ofintra-developing country trade was conducted in the 1970-80s. Clearing trade--whereby two or morecountries agree to exchange a number of specific products over one or more years and the value of thetraded goods is denominated in accounting units expressed in major currencies such as the U.S. dollar orthe Swiss franc--has now been practically phased out in international commerce. In the 1970s, however,it accounted for an estimated 10% of world trade.

Because the format and use of countertrade transactions have evolved over the years, this paper willuse the term “countertrade” in a generic sense.

The term will denote practices whereby foreign suppliers commit, as a condition of sale, to reciprocateand undertake certain contractually specified commercial initiatives that “compensat&’ the buyersthrough transfers of various agreed upon economic benefits (e.g., payments in kind that minimize oravoid net hard currency outlays by buyers, marketing assistance in third markets, investments and jobcreation in the buyer’s country, or a combination of these.)

I. The 1970s and 19805

Judging by analyses of reported transactions, the number of countertrade transactions apparently

peaked in the mid-1980s or in the later part of that decade in the number of transactions executed and

their dollar value.

The actual volume of such deals, as a percent of total world trade, can only be estimated because of the

spotty information available. Contributing to widely varying figures are assessments that either lump

together or exclude different categories of compensatory arrangements (e.g. government-to-

government clearing agreements, military offsets).

The uneven reporting on countertrade

transactions also leaves unresolved

questions about the unreported volume

ofsuch transactions and about the

extent to which compensatory

obligations are actually fulfilled

according to contracted terms.

Estimates in the mid-1980s placed the annual volume of international deals conducted under the

generic label of countertrade between 5% and 25% of total world trade--that is, somewhere between

about $80 and $240 billion.

Also significant was the rapid geographical spread of the practice during the 1970-SOs. A study based on

a survey of 110 U.S. firms by the National Foreign Trade Council Foundation reported that the number

of countries making countertrade demands increased from 15 in 1972, to 27 in 1979, to 88 in 1983.

An alternate indicator of rising countertrade pressures during the period was the involvement of the

U.S. business community with the practice

• A U.S. International Trade Commission study that surveyed 523 U.S. corporations accounting for $127

billion in export sales in 1984 (about 60% of total U.S. export sales that year), reported that 5.6% of

military and non-military export sales that year involved countertrade obligations.

The study reported that between 1980 and 1984, defense countertrade obligations of U.S. firms

increased from $414 million to $2,182 million, while non-military countertrade obligations increased

from $467 million to $580 million.

Developing Countries: Countertrade with developing countries constituted the bulk of such deals

between suppliers from industrialized countries and developing country importers in the 1970-80s.

The transactions involved traditional Third World exports--mostly agricultural commodities and crude

oil.

By the mid-1980s, supply and demand constraints in volatile commodity markets contributed to a

leveling in the volume of countertrade commodity deals, while countertrade arrangements involving

value-added processing and buy-backs of light industry goods and low-technology components

multiplied, particularly in China and other South-East Asian countries.

The format of countertrade transactions and the nature of the assets exchanged also evolved during thelate 1980s, reflecting increased sophistication in structuring such deals and the inclusion of a broader

asset basis in countertrade arrangements.

In addition to physical goods, such as equipment and commodities, items transferred under reciprocally-linked deals included services such as transportation services and construction engineering, intellectualproperty rights such as licensing, rights to the use of assets such as leasing, and even outstanding

commercial and national debt which was settled through repayments in products(e.g., commercialdebt-for-product swaps in Peru and settlement of Libyan government debt through oil deliveries.)

A major application of countertrade in the 1970s was in buy-back transactions--a contractual agreementwhereby foreign contractors accept as full or partial repayment goods derived from the plant ormachinery they supplied.

Buy-back arrangements financed construction of much of the new production capacity in the SovietUnion.

Countertrade techniques were also used occasionally in freeing blocked soft currency funds.

These funds--held in countries with currency controls, such as India and the former Yugoslavia, andrepresenting local earnings by foreign firms or nationals--were sold at a discount, with officialpermission, to other Western parties who used them to cover local costs for such activities as producingfilms.

Industrialized Countries: Counter-trade practices were not solely restricted to trade with developingcountries, as evidenced by the creation in the 1980s of public units in industrialized countries entrustedwith administering compliance with both defense and non-military offsets.

Offsets--an umbrella term for a broad range of industrial and commercial compensation practicesrequired of foreign suppliers under primarily government agency of state-owned enterpriseacquisitions--were made a common requirement for the procurement of either military (e.g., fighteraircraft) or high-cost civilian hardware (e.g., commercial aircraft).

Both defense and non-military offsets may entail overseas co-production of the procured item, as wellas other economically beneficial transfers to the importing country that are not related to the originalexport.

Industrialized countries that established offset programs tied to both civilian and military procurementsin the 1980s include Australia, Austria, Belgium, Canada, Greece, Turkey, Portugal, Norway, Sweden,Finland, and Spain.

To assist their exporters some industrialized country governments also promoted countertrade under

government agreements.

For example, the French Ministry of Agriculture signed in 1989 an agreement with the USSR Council of

Ministers which provided for exchanges of Soviet commodities for French agricultural and food

processing equipment and technologies.

Other Western governments, such as those of the United States, Canada, Belgium, Holland, the United

Kingdom, and Italy, established special countertrade service units within public agencies to provide

countertrade-related advisory assistance to their exporters.

The French Government has supported instead the formation of a separate countertrade assistance

entity in the private sector. The Swedish Government was until 1990 a major stockholder, through

interests by the Swedish Investment Bank, in a private sector company involved in countertrade, Sukab.

II. The 1990s

In the 1990s, countertrade pressures abated in many parts of the world, notably Latin America as a

result of debt reduction induced by the Brady Plan initiative, lower international interest rates, policies

that liberalized trade regimes, and the emergence of economic blocs such as NAFTA (U.S., Canada,

Mexico), and MERCOSUR (Brazil, Argentina, Uruguay, Paraguay) which integrate regional trade based on

free market principles.

International countertrade practices are now increasingly associated with bidding on major defense and

non-military government procurement contracts and with project financing--a contract-based, off-

balance-sheet finance technique whereby revenues generated from the output of the financed project

are directly allocated to service outstanding debt and principal.

A variation of the countertrade buy-back contract which links foreign contractors’ repayments to the

output products of the production capacity they supplied, project financing relies instead mainly on

contractual recourse to the project’s revenue streams.

Strongest pressures for compensatory arrangements are currently tied to offsets in government

procurements. The end of the geopolitical struggle against communism has shifted the focus of global

rivalry to the commercial arena--mainly commercial competition among industrialized democracies.

Shrinking national defense spending in Western countries (over 35% in the U.S. since 1990) and

declining international orders for weapons are forcing U.S. defense contractors to undergo mergers and

to outbid each other for declining sales in the international marketplace--mostly by increasing the level

of the offset obligations they assume.

On their part, developing country governments are increasingly shifting their focus to civil

procurements--commercial aircraft, industrial plants, and especially infrastructure projects such as

roads, telecommunications, and power projects.

(According to the World Bank, developing countries are now spending around $200 billion a year on newinfrastructure investment, one-fifth of their total investment.)

High procurement costs and tighter budgets have prompted many emerging country governments in the1990s to issue new civilian offset regulations (e.g., United Arab Emirates, Kuwait).

Civil offset requirements, therefore, are increasingly acquiring a financing rationale in these markets.

In a global environment of budgetary constraints, the ability of suppliers to meet offset requirementsand/or to provide their clients with financial packages that can best those of competing bidders is amajor competitive edge.

Countertrade pressures are also on the rise in the former Soviet bloc countries.

Since the advent of “perestroika,” the emerging democracies of Eastern Europe and the successor statesto the former Soviet Union have embarked on a path of gradual economic reform, shifting away fromcentral planning toward individual forms of market-driven economies.

The nations’ requirements for huge amounts of foreign funds are, however, constrained by thecountries’ limited number of investment and/or business opportunities, by low creditworthiness, and bythe need to compete for private capital with more profitable and risk-free markets.

Today, Eastern Europe and the newly independent republics of the former Soviet Union still grapplewith economic dislocations associated with reforming and reconstructing their obsolescent economies.The self-financing aspects of countertrade arrangements appeal to these countries’ governments as onealternative for financing trade and investment linked to privatization and modernization of existingproduction capacity.

Countertrade practices have traditionally played a significant role in the commerce of the formercommand economies of Eastern Europe and the Soviet Union.

In the late 1980s, well over half of the former Soviet Union’s trade was conducted on the basis ofcountertrade, the bulk of it under bilateral clearing agreements with Central Europe and a number ofdeveloping countries.

The concept of payment in goods lent itself well to the region’s centrally-planned system which was notbased on profit-oriented flows of money as a me dium for settling transactions, but on an accountingsystem for uses of domestic resources.

Faced with declining intra-regional trade levels and dislocations in feed-stock sources induced by thedemise of the regional clearing system, the Newly Independent States (NIS) of the former Soviet Unionare restoring former commercial links between themselves and with East European countries byconducting a significant portion of trade on the basis of cashless barter.

According to the Russian State Statistics Committee, barter transactions accounted for 11.5% of allRussian exports in 1993 ($4.9 billion), compared with 8.3% in 1992.

This figure is a lower limit since it does not account for buy-back transactions, unreported non-

government barter deals, and countertrade arrangements financed through offshore escrows. The

Russian Government has also bartered products (including military hardware) to settle outstanding debt

owed to Turkey, Hungary, Finland, and South Korea.

Other former Soviet republics, less versed in bilateral barter agreements than Moscow, have been more

reluctant to enter into such arrangements. All exert strict controls on barter and countertrade deals

involving strategic raw materials.

Barter arrangements are, however, impractical in trade with Western suppliers because such deals

seldom satisfy the trading partners’ coincidence of needs for each other’s products.

Because Western suppliers can no longer rely on commercial credit extensions to finance the export leg

of countertrade transactions, they must now generate in advance, on behalf ofthe NIS importer, the

foreign exchange required to finance the Western export.

The advance generation of foreign exchange is accomplished through the sale of NIS goods whose

proceeds are then escrowed offshore in order to secure timely payments to the Western suppliers.

Hence, the emergence and proliferation of offshore escrow accounts endowed by commodity sale

proceeds which have now substituted for previous countertrade practices involving linked, financially

settled, and offsetting import-export contracts.

Escrow-financed trade that relies on commodity exports has become a significant and common tool in

trade of the Russian Federation. In 1992, the Russian Market Research Institute of the Ministry of

Foreign Economic Relations estimated that about 10% of annual hard currency export revenues--or as

much as $4 billion annually--is escrowed abroad.

About 80% of these funds is then used to finance imports into Russia. In 1994, the Russian Central Bank

raised these estimates. According to the bank, about $22-23 billion was escrowed offshore in 1992 and

1993, out of a total value of $70 billion exported in two years.

Escrow-financed trade appears to enjoy the support of both central and regional governments in the

Russian Federation, as regions and major energy producers are entitled to retain hard currency earnings

derived from exporting a portion of their production for their own development.

In 1992, approximately 10% of the production of Russian regions was exported through such regional

quotas. For production enterprises, countertrade fulfills a role that ranges from financing critical imports

to stashing foreign exchange export-revenues offshore.

III. Conclusions

Worldwide economic liberalization measures are now providing new business opportunities for

industrial country exporters and investors, while global trends for increased reliance on private capital

flows and decreased dependence on sovereign guarantees are pushing contract-based financingtechniques to the fore.

These trends portend that contract-based financing tools such as countertrade--not withstanding anyheightened costs and risks they pose to the trading parties--will likely continue to find use in trade withdebt-ridden countries for transactions lacking cover from multilateral development banks and Westernexport credit agencies.

By relying on multiyear marketing commitments for counter-delivered goods, countertradearrangements ensure continuity in repayment flows.

In the absence of sovereign guarantees, countertrade contracts may also provide a legal mechanismthat could enhance the opportunity for liquidating debt in case of default on the part of one of theparties to the contract.

Thus, financing based on countertrade and other similar contract-based self-liquidating financingarrangements is likely to continue as a way of supplementing traditional export finance business.

Key to the market acceptance and successful outcome of such transactions will, however, be the waycosts and risks will be shared among trading parties, inclusive of government agencies.

WHY COUNTERTRADE IS GETTfl\G HOT - June 29, 1992 Page 1 of 2

- -

Enter quotes Search Fortune — 1f1Ti’I

!IMoneycom- News I Markets I TeehnologyPersonal Finance; Small Basleess CNN.com

Fortune Magazine

Home j Fortune 500 Technology Investing 1anaoement 1 Rankings Video Newsletters RSS

WHY COUNTERTRADE IS GETTING HOTBy Shelley Neumeier

June 29, 1992

(FORTUNE Magazine) — Uganda wanted 18 helicopters to help stamp out elephant and rhino

poaching but didn’t have the $25 million to pay for them. Enter Gary Pacific, head of countertrade for

McDonnell Douglas Helicopter. Pacific helped set up several local projects that generate hard

currency, including a plant that will catch and process Nile perch and a factory to turn pineapples and

passion fruit into concentrate. Pacific says he’s already found buyers in Europe. Delivery of the

helicopters will start in 14 months. Such circuitous deals, long at the fringe of trade, are becoming

more common as U.S. companies hungrily search for opportunity in the developing world. Dan West,

chairman of the American Countertrade Association (ACA) in St. Louis and director of countertrade

for Monsanto, estimates that this type of trade now accounts for 20% of U.S. exports. That’s close to

$110 billion of goods and services. No government figures support this estimate (there are no

reporting requirements); West bases his guess on an informal survey of colleagues in his

association. Most are FORTUNE 500 heavyweights, including 33 of America’s top exporters (See

Trade), but some are companies such as Arcon Manufacturing of Charlotte, North Carolina, which

makes grain silos. What’s incontrovertible is the growth of ACA: About 40% of ts 176 member

companies joined the six-year- old organization during the past 18 months. Says Neil Caplan, who

handles such matters for Continental Grain: “Countertrade is here to stay. It’s a fact of life in certain

markets.” These include countries in Eastern Europe and the former Soviet Union that want Western

goods and technology but lack the hard currency to pay for them, as well as other emerging markets.

The ACA runs semiannual training seminars and offers a network Of countertrade cognoscenti who

are willing to share their experience and knowledge, Its new members include many who had not

previously thought much about countertrade --or even exporting. Richard Frankenheimer, who runs

the trade finance division of Nynex, says his company recently joined because “we need to be

conversant in whatever techniques are in vogue so we can win bids overseas.” Maybe you’ll get an

insert with your phone bill one day offering a few pounds of perch at an irresistible price.

CHART: NOT AVAILABLE CREDIT: RENEE KLEIN FOR FORTUNE/SOURCE: ACA CAPTION:

TRADE TRICKS The American Countertrade Association’s membership reflects the diverse

companies bargaining for business in cash-poor countries.

More from FortuneRIP muni bond insurance

Car advice WIts do buyers trustmOStrt

Taking the social media plungeLearning to let go

FORTUNE 500Current IssueSubscribe to Fortune

Morn Company NewsNational Enquirer parent plans bankruptcy filing

AIG moves info the black for top holder U S

How the roof fell in on Countrywide

The Hot List

100 best paces to start a business

-..

Hitachi reduces costs and CO2 emissions...

Top StoilesStocks at standstill ahead of Fed

Don’t rule out Fed ‘shock and awe’ - The Buzz

Most expensive colleges

Home prices still fumbling

JP Morgan faces SEC subprime probe

httn://monev .cnn.comlmagazines/fortune/fortune archive! I 992/06/29/76602/index.htm 11/1/2010

United States Code: Title 15,4712. Barter and countertrade I Eli/Legal Information Instit... Page 1 of 2

Search Law School Search Cornell

T IT home search find a lawyer donateLI1 / Legal Information Institute-

US CodeIt4

main page faq indes search —

TiTLE 15> cHAPTeR 73> SUBcHAPTER II> § 4712

§ 4712. Barter and counteitrade(a) Interagency group

(1) Establishment

The President shall establish an interagency group on countertrade, to be composed of representatives of such departments andagencies of the United States as the President considers appropriate. The Secretary of Commerce shall be the chairman of theinteragency group.

(2) Functions

It shall be the function of the interagency group to—

(A) review and evaluate—

(i) United States policy on countertrade and offsets, in light of current trends in international countertrade and offsetsand the impact of those trends on the United States economy;

(ii) the use of countertrade and offsets in United States exports and bilateral United States foreign economic assistanceprograms; and

(iii) the need for and the feasibility of negotiating with other countries, through the Organization for EconomicCooperation and Development and other appropriate international organizations, to reach agreements on the use ofcountertrade and offsets; and

(B) make recommendations to the President and the Congress on the basis of the review and evaluation referred to insubparagraph (A).

(3) Sharing of information

Other departments and agencies of the United States shall provide to the interagency group such information available to suchdepartments and agencies as the interagency group may request, except that the requirements, including penalties for violationthereof, for preserving the confidentiality of such information which are applicable to the officials, employees, experts, or consultantsof such departments and agencies shall apply in the same manner to each member of the interagency group and to any other parsonperforming any function under this subsection.

(b) Office of Barter

(1) Establishment

There is established, within the International Trade Administration of the Department of commerce, the Office of Barter (hereafter inthis section referred to as the “Office”).

(2) Director

There shall be at the head of the Office a Director, who shall be appointed by the Secretary of Commerce.

(3) Staff

The Secretary of Commerce shall transfer such staff to the Office as the Secretary determines is necessary to enable the Office tocarry out its functions under this section.

(4) Functions

It shall be the function of the Office to—

(A) monitor information relating to trends in international barter;

(B) organize and disseminate information relating to international barter in a manner useful to business firms, educationalinstitutions, export-related Federal, State, and local government agencies, end other interested persons, including publishingperiodic lists of known commercial opportunities for barter transactions beneficial to United States enterprises;

(C) notify Federal agencies with operations abroad of instances where it would be beneficial to the United States for theFederal Government to barter Govemment-owned surplus commodities for goods and services purchased abroad by the FederalGovernment; and

http://www.law.cornell.eduluscode/htmlluscode15/usc sec 15 0000471 2----000-.html 1 1/1 /7fl1 0

Barter, countertrade, corporate barter, barter marketplace - Learn from Barter News Page 1 of2

rLE3J mpaed.menu

Barter Companies Worldwide

The Barter Organizations in This Online

Directory Annually Move

Billions In Goods And Services, and Interact

with over 400,000 Companies Worldwide

If you would like to add you company listing to

our heavily trafficked websiteClick: New Listing

If you would like to modify or change yourexisting listing

Click: Modify Listing

Viwe quaan(e

you newcustOmTS —.....-

Read The BarterNewsBIo.comNew contacts, strategies and techniques

seven days a week!-->

Tuesday’s ReportThe weekty newsletter for everyone interested in hotter.

www.borternews.com

Ffrst Time VisitorsClick here

USA Barter Organizations

We KnowRetail BarterBarteNews

The OffidoI Jornd of the Rdprood Trodo Industry

Ourpurpose at BarterNewr is

to provide our readelT with a storehouseof informa:ion ideas contadi

949-831-0607

E-maiI

•BizXchang!rtpovin5 Bs tess wt, Trde

Need Up To S2mtIIIos For Veer Markethi?

HOME

l,j-f-r I rtpi-npsjjc nm!mrinnapre/wor1dwjde.htm 11/1/2010

Barter, countertrade, corporate barter, barter marketplace - Learn from Barter News Page 2 of 2

Africa Argentina Australia

j Austria Belgium Brazil

Canada Chile China

Columbia Czech lepublic Denmark jEgypt ] France Germany

Hong F Hungary Xceland

[ India Italy Jamaica

F Japan Jordan Korea (South)

Kuwait Lebanon Malaysia

Mexico Netherlands New Caledonia

New Zealand Panama Poriiania

Fus.sia Scotland Singapore

Slovak Republic South Africa Spain

Sri Lanka Thailand Turkey

United Kingdom United Arab Emirates

http://bartemews.comJmappage/wor1cjwjdehm 11/1/2010

ENERGY COOPERATION AGREEMENT Page 1 of6

Embassy of the Republic of Guyana, Caracas Venezuela

Consular Information I I Mainpage II Speeches by Ambassador Odeen Ishmael II Información en Español

Quinta Roraima, Prados del Este, Apartado 51051, Caracas 1050, Venezuela

Telephone: (58) 212 977-1158 - (58) 212-975-3687Fax: (58) 212 976-3765

embguy@cantv.net

ENERGY COOPERATION AGREEMENT PETROCARIBE

Post July 4th. 2005 - Back to Embassy page - Pictures of PetroCaribe summit

Text of PetroCaribe Agreement signed at Puerto Ia Cruz, Venezuela on 29 June 2005

We, the Heads of State and / or Government, gathered in the City of Puerto Ia Cruz, Venezuela,

within the framework of the Energy Meeting for the creation of PETROCARIBE:

1. WELCOME the initiative of the President of the Bolivarian Republic of Venezuela for the creation

of PETROCARIBE, the fundamental objective of which is to contribute to the energy security, the

social and economic development and the integration of the Countries of the Caribbean through the

sovereign use of energy resources based entirely on the principles for integration referred to as the

Bolivarian Alternative for the Americas (ALBA);

2. RATIFY the commitments assumed at the First Meeting of Energy Ministers of the Caribbean held

in Caracas, Venezuela, on 10 July 2004 and at the Second PETROCARIBE Meeting of Energy

Ministers held in Montego Bay, Jamaica, from 26 to 27 August 2004;

3. AGREE that, for the Latin American and the Caribbean region, integration is an essential

condition for striving to achieve development in the midst of the increasing creation of large

regional blocks occupying major positions in the world economy;

4. CONCLUDE that only integration based on cooperation, solidarity and the common will to

advance to higher levels of development can help fulfil the needs and aspirations of the peoples of

Latin America and the Caribbean while allowing them to preserve their independence, sovereignty

and identity;

5. REITERATE that the objective of PETROCARIBE is to help in the transformation of Latin American

and Caribbean societies by making them fairer, more educated, participatory and harmonious

nations. For this reason, PETROCARIBE has been conceived as an integral process intended to

promote the eradication of social inequalities and to foster improved living standards and more

effective participation by nations in their efforts to shape their own destiny;

6. RECOGNISE the need to adopt measures, within the context of PETROCARIBE, based on a

special and differentiated treatment for the Latin American and the Caribbean countries exhibiting

htttv /Iwww uvana.or/sanisb!petro agreement.html 11/1/2010

ENERGY COOPERATION AGREEMENT Page 2 of 6

less relative development, and on complementarity and cooperation between the countries of theregion;

7. GUARANTEE absolute respect for the principles governing the equality of States, sovereignty,non-interference in internal affairs, free determination and the right of each nation to freelydetermine the social, economic and political systems of its choice

8. CONCERNED about global economic trends and particularly about the policies and practiceswhich now prevail in industrialized countries and which may lead to a greater marginalization of thesmaller countries of the Third World whose economies are heavily dependant on foreign countries;

9. GIVEN the special circumstances of heavily indebted poor countries, all terms and conditions ofthe applicable financing arrangements will be determined through bilateral discussions with suchcountries;

10. RECOGNISE the importance of Trinidad & Tobago as an energy exporting country of theCARICOM as a reliable source of supply;

11. WE HAVE ACKNOWLEDGED that, within the context of an unfair economic order inherited fromcolonialism, and imposed by the wealthy developed and rich countries, the current global energy-related trends marked by the enormous waste of consumer societies, by the reduced availability ofproduction capacities and by speculation leading to the rise in hydrocarbon prices, have allcontinuously exerted a negative impact on both the economic performance of, and the socialconditions in the countries of the Caribbean. In most cases, the exports of these countries havebeen even more seriously affected by the fall in the prices of their products, mainly agriculturalproducts, such as sugar, bananas and others. In view of this situation, the countries of theCaribbean need to possess reliable sources of energy and must be assured that prices will notrepresent an obstacle to their development. For these reasons, we, the Heads of State and / orGovernment, have agreed to sign this:

AGREEMENT

On the basis of this Agreement, it has been decided to immediately create PETROCARIBE as a bodyaimed at facilitating the development of energy policies and plans for the integration of the nationsof the Caribbean through the sovereign use of natural energy resources to directly benefit theirpeoples. In this regard, PETROCARIBE will be responsible for coordinating and managing all issuesassociated with the energy-related links between the signatory countries in accordance with thisAgreement.

In order to guarantee the achievement of these objectives and given the dynamic nature andcomplexity of the energy issue, PETROCARIBE emerges as an organization capable of ensuring thecoordination and harmonization of energy policies, including oil and oil-derivatives, gas, electricityand the efficient use of these resources, technological cooperation, training, development of energyinfrastructure and the harnessing of alternative sources of energy such as wind, solar and otherkinds of energy.

I. INSTITUTIONAL PLATFORM

In order to achieve its objectives, PETROCARIRE shall be furnished with a Ministerial Councilformed by the Ministers of Energy or their equivalents and assigned the following functions:

* Coordinate relevant policies, strategies and plans;

* Delegate functions and responsibilities to the agencies created for the fulfilment of specific tasks,

http://www.guyana.org/spanish/petro agreement.html 11/1/2010

ENERGY COOPERATION AGREEMENT Page 3 of 6

99whenever necessary;

* Agree on and approve issues of absolute priority to the organization, as well as studies,

workshops and work sessions, with a view to providing the necessary technical and legal support

for these issues;

* Exercise its fullest authority with regard to the performance of the Executive Secretariat;

* Agree on the admission or withdrawal of members whenever required.

The Council of Ministers shall appoint a President and a Deputy, who shall call and chair the

meetings. Regular meetings shall be held once per year and special meetings shall be held as often

as needed.

PETROCARIBE shall also posses an Executive Secretariat ascribed to the Ministry of Energy and

Petroleum of the Bolivarian Republic of Venezuela and assigned the following functions:

* Prepare the agendas of the meetings of the Council of Ministers;

* Directly manage and administer PETROCARIBE-related affairs;

* Ensure the implementation and follow-up of the decisions adopted by the Council of Ministers and

submit the relevant reports and recommendations;

* Prioritize the studies and projects defined by the Council of Ministers;

* Propose the allocation of resources for the performance of all necessary studies.

IL ALBA CARIBE FUND FOR SOCIAL AND ECONOMIC DEVELOPMENT

In order to help foster the social and economic development of the countries of the Caribbean,

PETROCARIBE shall have at its disposal a Fund earmarked for the financing of social and economic

programs and consisting of contributions from financial and non-financial instruments. Such

contributions may, upon agreement, be drawn from the financed portion of oil invoicing and the

savings from direct trade.

This fund shall be called the ALBA-CARIBE Fund.

In order to activate the ALBA-CARIBE Fund, the Bolivarian Republic of Venezuela shall contribute

an initial capital of Fifty Million Dollars (US$50 million).

IlL OPERATING ASPECTS

1. With a view to commencing operations, Petroleos de Venezuela (PDVSA) has created a special

purpose affiliate under the business name of PDV CARIBE.

2. Upon beginning its operations, this affiliate shall possess adequate cargo capacity for covering

its various supply-related obligations.

3. Freight expenses arising from these operations shall be charged at cost price, which represents

additional savings for the signatories to this Agreement.

4. PDV CARIBE shall guarantee a direct trade relationship without intermediaries in the supply

httn://www.guyana.org/spanishlpetro agreement.html 11/1/2010

ENERGY COOPERATION AGREEMENT Page 4 of 6

process. This arrangement shall help generate additional savings for the consumer countries.

5. To this end, PDV CARIBE shall also be responsible for organizing a logistics network of ships,storage facilities and terminals. This will include, whenever possible, refining and distributionfacilities for fuels and products. Priority shall be given to countries in greatest need.

6. This affiliate shall adopt training programs designed to strengthen professional capacities and topromote a non-contaminating, more energy-efficient and more rational use of conventional energyand of renewable energy.

IV. FINANCING MECHANISMS AND COMPENSATIONS

Apart from the benefits set forth in the San José Agreement and in the Caracas Energy CooperationAgreement, the Bolivarian Republic of Venezuela shall extend credit facilities to the countries of theCaribbean exhibiting less relative development on the basis of bilaterally fixed quotas.

2. Long-term Financinq

With regard to financing,two years.

the grace period provided for in the CEA shall be extended from one to

3. Short-term Financing

The portion to be paid in the short-term shall be extended from thirty to ninety days.

4. Deferred Payment

The same bases of the Caracas Energy Cooperation Agreement shall apply for 17 years (includingthe 2-year grace period mentioned), provided that the price per barrel remains below 40 dollars.

Should the price per barrel exceed 40 dollars, the payment period shall be extended to 25 years,including the 2-year grace period specified at 1% interest. With regard to deferred payments,Venezuela shall be able to determine the portion that shall be paid with goods and services forwhich it shall offer preferential rates.

>= 20 dollars per barrel 10

>= 22 dollars per barrel 1115>= 24 dollars per barrel

PRICE PER BARREL (%)PERCENTAGETO BE FINANCED

>= l5dollarsperbarrel

I 1120>= 30 dollars per barrel 25

>= 40 dollars per barrel 1 30

> 50 dollars per barrel 1140

>= 100 dollars per barrel 1150 I

http://www.guyana.org/spanishlpetro_agreement.html 11/1/2010

ENERGY COOPERATION AGREEMENT Page 5 of 6

The products that Venezuela may purchase at preferential rates may include certain items such as

sugar, bananas or other goods or services to be determined that are believed to be affected by the

trade policies of rich countries.

V. ENERGY EFFICIENCY

One essential feature of the objective of PETROCARIBE shall be to add energy saving programs to

supply-related agreements. In this regard, PETROCARIBE may arrange credits and exchange

technologies to enable beneficiary countries to develop highly functional energy-efficient programs

and systems, as well as other measures making it possible for them to reduce their oil consumption

and to provide a wider range of services.

VI. THE ACTORS

Within the framework of PETPOCAR1BE, state bodies shall be required to implement energy-related

operations. Venezuela offers technical cooperation to support the creation of state agencies in

countries not possessing qualified state institutions for this purpose.

This Agreement is signed in two original and equally authentic copies drafted in English and

Spanish in the City of Puerto Ia Cruz, on 29 June 2005 by:

Willmoth DanielDeputy Prime Minister of Antigua and Barbuda

Leslie MillerMinister of Trade and Industry of the Bahamas

Vildo MannMinister of Health, Energy and Communications of Belize

Fidel Castro RuzPresident of the State Council and the Government of the Republic of Cuba

Roosevelt SkerritPrime Minister of Commonwealth of Dominica

Leonel FernandezPresident of the Dominican Republic

Keith MitchellPrime Minister of Grenada

Samuel HindsPrime Minister of the Cooperative Republic of Guyana

Percival PattersonPrime Minister of Jamaica

Ralph GonsalvesPrime Minister of St. Vincent and the Grenadines

Petrus ComptonMinister of Foreign Affairs, International Trade and Civil Aviation of St. Lucia

http://www.guyana.org/spanishIpetroagreernent.htm1 11/1/2010

ENERGY COOPERATION AGREEMENT Page 6 of 6

3o-Earl Asim MartinMinister of Public Affairs and Energy of St. Kitts and Nevis

Jules Rattankoemar AjodhiaVice President of the the Republic of Suriname

Hugo ChavezPresident of the Bolivarian Republic of Venezuela

This page is part of Guyana News and Information.(http://www.guyana.org)

http://www.guyanaorg/spanishIpetro_agreement.htm1 11 / 1/2010

o3

EXCERPT FROM Caribbean Business Growth Potential

During the Global Recession through Countertrade: Exhibit A — The Petrocaribe.

The Petrocaribe as a Multilateral Clearing System.

One Caribbean opportunity for countertrade is through the expanding scope of the Energy

Cooperation Agreement Petrocaribe, (“Petrocaribe”). The system is not based on commercial private

profiteering, but on the need of similarly situated nations to meet regional needs not otherwise

provided from industrialized nations. On June 29, 2005, fourteen Caribbean and Mexican countries,

including Jamaica, the Bahamas, Dominica, the Dominican Republic and Haiti, formed an alliance to

enhance access to energy resources at a more advantageous price than it received from industrialized

nations. Spurred into action from sudden increases of oil prices in 2005, they believed exchanging crude

oil and related products among themselves regionally, with flexible payment terms was superior to the

existing arrangements with industrialized countries. Apparently uncontroverted figures reveal

unprecedented transactional efficiencies and significant economic development have already occurred

from the accord.

The primary beneficiaries are the countries that depend largely on imported oil. The benefactor

has been Venezuela, a major producer of crude oil. Jamaica was an early member and its bilateral

agreement illustrates the terms. Under the original agreement, Venezuela provided 29,000 barrels per

day at lower price that provided from prior sources outside the region.’ Payment terms were

advantageous to Jamaica in that it only had to pay 80% of the total cost from its own resources, with a

20% low interest loan for devel6pment projects over a 15 year period when the price of oil exceeded a

particular price per barrel. As an accountability provision, Jamaica would have to settle the loan on an

accelerated basis (5 years) if the development projects did not come to fruition. The total terms were

reviewed annually, and became more favorable to Venezuela over time. This bilateral agreement allows

Jamaica to access 7.4 barrels of oil annually at a cost of only $15-30 per barrel. 2 Jamaica included the

ability to process its own crude oil under the Petrocaribe agreement (Petrojam) further reducing its long

term costs.3

The success of the Petrocaribe became evident and the accord expanded to 18 members,

representing over 88 million Latin and Caribbean inhabitants.4Petrocaribe sources assert that from

2007-2009, 14 of the 18 members reported increased volume of oil from 59 thousand barrels to 121

thousand barrels daily, comprising a 105% increase over that period.5 Increased oil supply at lower cost,

and refineries for oil and electric power generation also added 59,647 direct and indirect job5 through

1 http://petcomja.com/alliance main.htm last visited 6-19-09.2 http://petcomia.com/alliance main.htm last visited 6-19-09.

http://eetcomla.com/alliance main.htm last visited 6-19-09.

http://www.pdvsa.com/ifldex.PhP?tPlinterfaCe.efl/deSiRn/bibliOteCa/readdOC.tpl.html&new

http://www.pdvsa.com/index.php?tPlinterface.efl/deSifl/biblioteCafre8ddOC.tPl.html&fleW

eleven new joint ventures in the region.6The same source concludes that the overall decrease in energy

costs and positive economic benefits generated $1.4 billion in tangible savings

Additional Caribbean nation states are seriously considering joining the alliance. Most recently,

St. Lucia publicly stated its intent to “commence, advance and become full member... with

implementation of the crude oil supply agreements”.7In the two years since Guyana participated in

Petrocaribe, it has imported approximately 2.3 million barrels of oil and by-products.8Guyana’s prime

minister opines that the agreement has contributed to an improved standard of living for its citizenry.9

6 Id.Petrocaribe official website, Petrocaribe Energy for Union, 2009,

http://www.petrocaribe.org/index.php?tplinterface.en/desigfl/SalaPrenSa/readmeflu.tQI.html&fleWSid obi id=7

17&newsid temas=1 last visited 6-20-09.

Id.Id.

30